Understanding the IT environment of the entity

Session objectives Defining contours of financial accounting in an IT environment and its characteristics Assessing the impact of IT on financial audit Identifying controls in IT systems Explaining objective and scope of Financial Audit in IT environment Checking effectiveness of controls Designing audit procedures Explaining the importance of electronic documentation

Financial Audit in an IT environment The Auditing Standards of the Comptroller and Auditor General of India require that “Where accounting or other information systems are computerized, the auditor should determine whether internal controls are functioning properly to ensure the integrity, reliability and completeness of the data.”

Contours of Financial Accounting in IT Environment Financial Accounting software and hardware of the entity Other business Application Systems of the entity e – Commerce, EDI, EFT, Office Automation systems, ATM Purchase Accounting system Inventory Control systems Pay roll systems Accounts receivables and payables systems Controls and risks in the IT environment of the entity

Management and Organisation People Management Change and Technology Management Focus on best practices Security Outsourcing Data Management Contours of Financial Accounting in IT Environment II

Characteristics of IT Systems Concentration of functions and knowledge Concentration of computer programs and data Absence of input documents Lack of visible transaction trail Lack of visible output Accessibility of data and programs – Risk involved Consistency of performance Vulnerability of data and program storage media

Impact of IT on Financial Audit Financial Audit Objective in an IT Environment – Changed Risk Perception Understanding of system essential for Planning Identifying Internal Controls in an IT Environment a must for audit Changed data retrieval methods and Substantive Tests in audit Use of Advanced Auditing Techniques CAATs, Simulation, Test Data

Identifying controls in an IT system I Controls reflect the policies, procedures, practices and organizational structures designed to provide reasonable assurance that the intended objectives of the entity will be achieved. They ensure effectiveness and efficiency of operations, reliability of financial reporting and compliance with the rules and regulations. However, computer systems are efficient only if they function in the manner they are designed to and the controls provided are effective.

Identifying controls in an IT system II Thus it is important for the Auditor to verify that not only adequate controls exist, but that they also function effectively. Such controls should also be commensurate with the risk assessed so as to reduce the impact of identified risks to acceptable levels.

Objectives of computer controls Achieving effective organizational control over functions related to data processing by clearly defining organizational objectives Achieving effective management control over development of data processing resources in conformity with organizational objectives Adopting practices related to data processing activities in accordance with statutory requirements and prescribed administrative procedures Adhering to policies, standards and procedures in respect of all data processing functions Assuring efficiency and effectiveness of the data processing systems geared towards achievement of the desired objectives

General controls General controls are controls over data centre operations, system software acquisition and maintenance, access security, and application system development and maintenance General Controls create the environment in which the application systems and application controls operate e.g. IT policies, standards, and guidelines pertaining to IT security and information protection, application software development and change controls, segregation of duties, service continuity planning, IT project management, etc.

Application Controls Application controls pertain to specific computer applications and include controls that help to ensure proper authorization, completeness, accuracy and validity of transactions, maintenance; and other types of data input

Application controls Examples include system edit checks to help prevent possible invalid inputs system-enforced transaction controls that prevent users from performing transactions that are not part of their normal duties the creation of detailed reports and transaction control totals that can be balanced by various units to the source data to ensure that all transactions have been posted completely and accurately.

Financial Audit in an IT environment The overall objective and scope of an audit remains same in an IT environment. The processing, storage, retrieval and communication of financial information changes, which may affect the accounting and internal control systems employed by the auditee organization. Thus IT environment may affect: the procedures followed by the auditor in obtaining a sufficient understanding of the accounting and internal control systems the auditor’s evaluation of inherent risk and control risk through which the auditor arrives at the risk assessment the auditor’s design and performance of tests of control and substantive procedures appropriate to meet the audit objective

Financial Audit in an IT environment While determining the effect of the IT environment on the financial audit, the auditor should evaluate, the extent to which the IT environment is used to record, compile and analyze accounting information; the system of internal control in existence in the auditee organization with regard to flow of authorized, correct and complete data to the processing center processing, analysis and reporting tasks undertaken in the installation the impact of computer-based accounting system on the audit trail that could otherwise be expected to exist in an entirely manual system.

To check effectiveness of controls Effectiveness of controls over the information technology processes that have a direct impact on the processing of financial information could be judged by the following procedures: determine the scope of audit analysis of the information technology processes by identifying how they support important business processes and the processing of financial information; obtain background information about the auditee organization’s IT environment, including information about and applications supporting the critical business processes, together with the underlying platforms and those to which they are networked;

To check effectiveness of controls Conduct a walk-through of those information technology processes deemed to have a direct and important effect on the processing of financial information to confirm the auditor’s understanding of the process design and related controls; and Based upon the understanding of the information technology processes, evaluate the effectiveness of the design of each of the major information technology processes and related internal controls.

To evaluate reliability of accounting and controls The auditor should check whether the systems: ensure that authorised, correct and complete data is made available for processing; provide for timely detection and correction of errors; ensure that in case of interruption in the working of the IT environment due to power, mechanical or processing failures, the system restarts without distorting the completion of the entries and records; ensure the accuracy and completeness of output; provide adequate data security against fire and other calamities, wrong processing, frauds etc.; prevent unauthorized amendments to the programs; and provide for safe custody of source code of application software and data files.

Audit procedures The auditor should consider the IT environment in designing audit procedures to reduce audit risk to an acceptably low level. He should check whether: adequate procedures exist to ensure that the data transmitted is correct and complete; and cross-verification of records, reconciliation statements and control systems between primary and subsidiary records do exist and are operative and that accuracy of computer compiled records is not assumed. The methods of applying audit procedures to gather evidence may be influenced by the methods of computer processing.

Audit procedures The auditor can use manual audit procedures, or computer-assisted audit techniques, or a combination of both to obtain sufficient evidence. The IT Systems can help the auditor in using analytical procedures (for analyzing ratios and trends, identifying unusual items, etc.) and in using sampling techniques and generating random samples. IT Systems can facilitate the application of Monetary Unit Sampling, which is widely used in financial audit. The auditor can also extract the relevant records required by him using IDEA or other package.

Documentation The auditor should document the audit plan, the nature, timing and extent of audit procedures performed and the conclusions drawn from the evidence obtained. If audit evidence is in the electronic form, the auditor should satisfy himself that such evidence is adequately and safely stored and is retrievable in its entirety as and when required. The authenticity of the audit evidence should be ensured beyond all reasonable doubt.