1. AUDIT QUALITY AND ASSURANCE 2 ND AND 3 RD OCTOBER 2014 HILTON HOTEL ANALYTICAL PROCEDURES 1

2. CONTENT 1. Introduction 2. The Audit process 3. The audit strategy 4. Tests of Control 5. Substantive tests 6. Analytical procedures 2

3. 1. Quick Quiz!!! What is the difference between an Accountant and an Auditor? 3

4. 1. Quick Quiz!!! The accountant lies and the auditor confirms the lies! 4

5. 1. Introduction As we know from assurance principles, the objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared in all material aspects in accordance with an identified financial reporting framework. 5

6. 1. Introduction In order for the auditor to express an opinion, the auditor is required to gather audit evidence. So the auditor’s opinion is based on evidence. Audit evidence includes all the information contained within the accounting records underlying financial statements and other information say from third parties. 6

7. 1. Introduction In order to reach a position in which they can express the professional opinion, the auditor gathers evidence from various sources. There are two types of tests which they carry out: 1. Tests of control 2. Substantive procedures 7

8. 2. The audit process Obtaining evidence is done mostly through out the audit process. The process in summary is made up of: 1. Planning the audit (General strategy on the nature, timing and extent of the audit so as the auditor focuses on important areas) 8

9. 2. The audit process 2. Understand the business (Assess the risk of material assessment and nature of industry) 3. Tests of control 4. Substantive tests 5. Issue audit report 9

10. 3. The audit strategy In the process of collecting evidence, it is important to have an audit strategy which tends to be more broad as compared to an audit plan. 10

11. 3. The audit strategy An audit strategy sets the direction for the audit, describes expected scope and conduct of the audit and provides guidance for the development of the audit plan. 11

12. 3. The audit strategy An audit strategy sets the direction for the audit, describes expected scope and conduct of the audit and provides guidance for the development of the audit plan. Key contents are as follows: 12

13. 3. The audit strategy AreaComments Understand the entity’s environment1.Business 2.Business Strategy 3.Financial Performance 4.Reporting requirements 5.Management Competence Understanding the accounting and internal control systems 1.Accounting policies 2.New accounting requirements 3.Cummulative knowledge of the controls if it is not the first audit Risk and Materiality1.Expected assessment of risks of fraud 2.Setting materiality for audit planning 3.Complex accounting areas and fraud 13

14. 3. The audit strategy AreaComments Consequent nature, timing and extent of procedures 1.Possible change of emphasis on specific areas 2.Effect of information technology on the audit 3.Work of internal auditing Co-ordination, direction, supervision and review 1.Involvement of other auditors 2.Involvement of experts 3.Number of locations 4.Staffing requirements Other matters1.Going concern 2.Related parties 3.Statutory responsibilities 4.Reports 14

15. 3. The audit strategy In general an audit strategy will affect the way an auditor will conduct the tests of internal control and substantive procedures. Tests of control will include: 15

16. 4. Tests of Control 1. Inspection of documents 2. Inquiries about internal control 3. Re-performance of control procedures 16

17. 4. Tests of Control 4. Examination of evidence of management views 5. Testing internal controls on computerized systems. 6. Observation of controls Check how they were applied, consistency of application and who? 17

18. 4. Tests of Control During testing, the auditor can record internal controls as part of audit documentation: 1. Narrative notes 2. Flowcharts 3. Questionnaire 4. Checklists 18

19. 4. Tests of Control In addition the auditor is required to communicate to the management deficiencies in internal controls, the risk the deficiencies cause, the corrective action required. This is done via a Management Letter. 19

20. 5. Substantive procedures Substantive procedures are tests to obtain audit evidence to detect material misstatements in the financial statements. The extent and depth of Substantive procedures depend on various factors but mainly results of tests of control. They focus on Assertions. 20

21. 5. Substantive procedures Audit objective/ AssertionsTypical audit tests CompletenessReview of events after the SFP Cut off Analytical Review Confirmations Reconciliations to control accounts Sequence checks Rights and obligationsChecking invoices for proof that item belongs to the company Confirmation with third parties Valuation and allocationChecking to invoices Recalculation Confirming with accounting policies Review of payments and receipts after SFP date 21

22. 5. Substantive procedures Audit objective/ AssertionsTypical audit tests ExistencePhysical verifications Third party confirmations Cut off testing OccurrenceInspection of supporting documents Confirmation from Management Inspection of items purchased AccuracyRe- calculation of correct amounts Third party confirmations Analytical review ClassificationsCheck compliance with the law and accounting standards Check for True and fair view 22

23. 5. Substantive procedures Substantive tests are generally of two types: 1. Analytical procedures 2. Other detailed tests such as review of minutes of directors’ meetings and enquiry. We focus on Analytical procedures next: 23

24. 6. Analytical procedures (ISA 520) Analytical procedures means evaluations of financial information through analysis of plausible relationships among both financial and non- financial data. 24

25. 6. Analytical procedures (ISA 520) Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. 25

26. 6. Analytical procedures (ISA 520) When designing and performing substantive analytical procedures the auditor shall: 1. Determine the suitability of particular substantive analytical procedures for given assertions, taking account of the assessed risks of material misstatement and tests of details, if any, for these assertions; 26

27. 6. Analytical procedures (ISA 520) 2. Evaluate the reliability of data from which the auditor’s expectation of recorded amounts or ratios is developed, taking account of source, comparability, and nature and relevance of information available, and controls over preparation ; 27

28. 6. Analytical procedures (ISA 520) 3. Develop an expectation of recorded amounts or ratios and evaluate whether the expectation is sufficiently precise to identify a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated; 28

29. 6. Analytical procedures (ISA 520) 4. Determine the amount of any difference of recorded amounts from expected values that is acceptable without further investigation. 29

30. 6. Analytical procedures (ISA 520) The most important reasons for using analytical procedures are to: 1.Obtain knowledge about the client’s industry and business. 2.Help in assessing the ability of the entity to continue as a going concern. 30

31. 6. Analytical procedures (ISA 520) 3. Signal the possible presence of errors and fraud in the financial statements. (For example when there is unusual fluctuations in financial data). 4.Reduced detailed audit tests. 31

32. 6. Analytical procedures (ISA 520) Types of analytical procedures: 1. Trend analysis is the comparison of an account balance or item to the prior year balance or to a trend of balances from two or more prior periods. A common example is comparing the monthly totals for sales for the current and preceding year. 32

33. 6. Analytical procedures (ISA 520) 2. Ratio analysis is the comparison of a ratio calculated for the current period to a related or similar ratio for a prior period, an industry standard, or a budget. Financial and operating ratios are commonly classified into six major categories: liquidity, profitability, leverage, activity, cash flow, and Investor ratios. 33

34. 6. Analytical procedures (ISA 520) 3. Model-based procedures involve the use of client operating data and the relevant external data (industry information and general economic information) to develop an expectation for the account balance or item. These procedures typically use operating and external data, in addition to financial data to perform reasonableness tests. For example, the number of employees can be used to determine the average wages or vacation pay per employee. 34

35. 6. Analytical procedures (ISA 520) Whatever type of analytical procedures are used by the auditor, these procedures include comparisons of key current financial data to: Prior-period financial information. Budgeted and forecasted financial information. Similar information regarding the industry in which the entity operates. Nonfinancial information that may affect financial information. 35

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37. 6. Analytical procedures (ISA 520) Analytical procedures may be done at three stages: 1. Analytical procedures are required in the planning phase to assist in determining the nature, extent, and timing of audit procedures. This helps the auditor identify significant matters requiring special consideration later in the engagement. For example, the calculation of inventory turnover before inventory price tests are done may indicate the need for special care during those tests 37

38. 6. Analytical procedures (ISA 520) 2. Analytical procedures are often done during the testing phase of the audit as a substantive test in support of account balances. These tests are often done in conjunction with other audit procedures. For example, the prepaid portion of each insurance policy might be compared with the same policy for the previous year as a part of doing tests of prepaid insurance. 38

39. 6. Analytical procedures (ISA 520) 3. Analytical procedures are also required during the completion phase of the audit. Such tests serve as a final review for material misstatements or financial problems and help the auditor take a final “objective look” at the audited financial statements. Typically, a senior partner with extensive knowledge of the client’s business conducts the analytical procedures during the final review of the audit files and financial statements to identify possible oversights in an audit. 39

40. 6. Summary (ISA 520) 40

41. FINALLY..... Questions? 41