1. Environment Auditing in a Changing Dalma James
Dalma P James and Associates
2b West Ivy Green Crescent
Kingston 5
Phone: Fax:

2. Audit Planning, Execution & Audit Evidence
Dalma James
Dalma P James and Associates
2b West Ivy Green Crescent
Kingston 5
Phone: Fax:
Dalma P James and Associates

3. Changing Environment New accounting standards
Technology – data processing, communication and operations
Globalization
New laws and regulations:
Greater responsibility of directors and managers
More detained reporting on their stewardship
Concerns emanating from current/recent financial crisis
Constant .updates in the requirements of IAS, almost annual updates and radical changes creates pressure on the auditor to be current and to pay greater attention to what is being done by clients.
Computers and the internet are now making the possession of information and communication possible in ways inconceivable a few years ago.
Knowing a business process a few years ago does not guarantee that you will know it today. Or tomorrow. Look at printing. ( the processes have changed radically – allowing the reproduction of high quality prints at a fraction of the cost and a fraction of the time required yesterday) Information is now easy to obtain and to disseminate.
With globalization your competitor is no longer the shop down the road or even around the corner but someone on the other side of the globe. The result is that every activity is expected to add value to the business process (even auditing)
New acts and regulations also add their amount of pressure for change.
Dalma P James and Associates
Dalma P James and Associates

4. Douglas Carmichael, the chief auditor and director of professional standards of her Public Company Accounting Oversight Board, said:
“My hope is that auditors will respond to their new role ………..result will be a renewed spirit of professionalism and a dedication to the auditor’s role of protecting investors and furthering the public interest in the preparation of informative, fair and accurate independent audits.”
In Jamaica as well as in the rest of he world today’s directors and managers are expected to have greater accountability for governance, risk management and control.
We therefore find that clients are expecting that their auditors will add value to their business by assessing the effictiveness of these systems and procedures.
Dalma P James and Associates
Dalma P James and Associates

5. Overview
Audit work should be planned so that the audit will be performed in an effective manner.
The Planning entails the development of:
A general strategy (the overall audit plan); and
A detailed approach for the nature, timing and extent of the audit procedures (the audit programme)
Let us look at some of the matters to be considered in developing an overall audit plan:
Coordination, direction, supervision and review
Number of locations
Involvement of others (other auditors, internal audit, experts)
Audit deadlines
Terms of engagement eg systems review
Knowledge of the business:
State of the economy – local and international
Factors affecting the industry – skills shortage
Technological developments – use of e-commerce
Competence and business acumen of key management personnel
Risk and Materiality:
Known risk areas – going concern, target for a takeover
Likelihood of material error or fraud
Significance of related parties and related party transactions
Materiality threshold of transactions and balances to the balance sheet and income statement, accounting and internal control systems
Previous knowledge and experience of the adequacy of accounting information
Accounting policies and practices
Links between back office and front office systems
Extent to which the auditor expect to rely on the systems of internal control
Nature, timing and extent of procedures
Extent of computerisation and the availability of computer-assisted audit techniques
Work and findings of internal audit
Extent of reliance on internal controls
Use of substantive analytical procedures
Reporting deadlines
Dalma P James and Associates
Dalma P James and Associates

6. Objectives The objectives of the plan are to ensure that the auditor:
devote appropriate attention to important areas
identify potential problems
complete work expeditiously
assign and co-ordinate audit work appropriately
The above points may seem obvious, however without a structured and developed audit plan, it is probable that (although the objectives may be met). Audit resources will not be used efficiently. For example, the adoption of an audit approach where equal prominence is placed on all areas of the accounts of an entity, would almost certainly not be as efficient as a risk based approach.
The detailed audit work is commonly carried out by a team of audit staff with varying degrees of skill and experience. It is therefore imperative at the planning stage that careful consideration is given to the assignment of work to the members of the team so that individuals are not required to carry out audit tasks which are beyond their level of competence. Similarly, at the planning stage, due consideration should be given to the co-ordination of work to be carried out by experts or other auditors if appropriate.
Dalma P James and Associates
Dalma P James and Associates

7. Planning The work is to be adequately planned, and
assistants, if any, are to be properly supervised.
Acceptable audit risk – how willing is auditor to
accept that the financial statements may be materially
misstated after the audit is completed & the
opinion is issued.
The audit is carried out as an economic activity by the auditor; therefore the auditor must seek to achieve his objective in the most efficient manner. He should seek to avoid over-auditing while ensuring that the possibility of an incorrect opinion is minimised.
Dalma P James and Associates

8. Risk of Material Misstatement
Inherent risk – assessment of likelihood that there are
Material misstatements in accounts before considering
effectiveness of internal controls.
Control risk – assessment of likelihood that misstatements
exceeding a tolerable amount in accounts will not be
prevented or detected by the client’s internal controls.
Inherent risk:
An example of inherent risk: the valuation of inventory is inherently more risky when the type of inventory is difficult to value due to its nature, so the valuation of diamonds are inherently much more risky than, say, a pair of shoes
The assessment of inherent risk (and also control risk) is an exercise that requires professional judgment on the part of the auditor. Hence, two auditors assessing the same company may assess the inherent and control risks differently, but it is to be expected that their assessments should be in the same vicinity.
Control risk
Control risk represents the auditor's assessment of the likelihood that a material misstatement relating to an assertion in the financial statements will not be detected and corrected, on a timely basis, by the client's internal control system. To return to the example of an entity having an inventory of diamonds, which is inherently risky in terms of valuation: if the entity has competent, experienced valuers valuing its inventory, the control risk will be lower as compared to a situation where incompetent people are tasked with performing that function. The product of inherent risk and control risk is referred to as the Risk of Material Misstatement, and represents the risk that the auditor adequately has to respond to when doing substantive testing. It is permissable to do a combined assessment of inherent and control risk, instead of formally separating the two components as done above.
Suppose an auditor is doing the risk assessment relating to the completeness of trade payables assertion. He regards 5% as an acceptable audit risk, and has assessed the inherent risk at 70%, which is high. But he has also assessed the control risk relating to this assertion at 10%, which means that the client has strong controls in place "governing" this assertion. The auditor expects these controls to eliminate 90% of the misstatements that were likely due to the inherently risky nature of the assertion, leaving a low combined risk of slightly above 6% for him to respond to by means of his substantive testing.
Dalma P James and Associates
Dalma P James and Associates

9. The Audit Risk Model DR = (Detection risk) AR = (Audit risk)
(IR x CR) = (Inherent risk x Control risk)
Detection risk is the risk that a material misstatement is in the financial statements and the audit procedures do not detect that error.
Audit risk
Dalma P James and Associates
Dalma P James and Associates

10. The Audit Risk Model
Audit risk can be expressed in the following model which assumes the elements to be independent:
Audit risk (AR) = Inherent risk (IR) x Control risk (CR) x Detection risk (DR).
AR = IRxCRxDR
Audit risk:
In other words the possibility that the audit opinion is incorrect.
Dalma P James and Associates
Dalma P James and Associates

11. Preliminary Assessment of Planning Materiality
Materiality is considered to be the largest amount of uncorrected dollar misstatement that could exist in published financial statements, yet still be fairly presented in conformity with IAS (i.e. not misleading).
This concept is often difficult for junior staff and non auditors to grasp. It must be set by senior audit staff at the planning stage and enforced throughout the audit. Failure to do so will affect the efficiency of the audit process.
IASC Framework
‘Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements’
As a yardstick materiality must be relevant to the user rather than the preparer of financial statements.
Dalma P James and Associates
Dalma P James and Associates

12. Planning Materiality
Some of the common factors auditors use in making judgment are:
absolute size,
relative size,
nature of the item or issue,
circumstances,
uncertainty, and
cumulative effects.
An otherwise immaterial item may be considered material if:
Profit to loss or vise versa
net current assets to net current liabilities (Though this is not required to be shown in the BS now.
Some items such as director’s emoluments and share capital can be determined with precision therefore errors are expected to be determined and corrected.
Dalma P James and Associates
Dalma P James and Associates

13. Planning Materiality
The concept of materiality is used by auditors as a guide
to planning the audit program,
to evaluation of the evidence, and
for making decisions about the audit report.
There is an inverse relationship between materiality and the level of audit risk.
Dalma P James and Associates
Dalma P James and Associates

14. Planning an Audit and Designing an Approach
I. Accept client and
perform initial
audit planning
III. Assess client
business risk
II. Understand the
client’s business
and industry
IV. Perform preliminary
Analytical procedures
Dalma P James and Associates

15. Planning an Audit and Designing an Approach
V. Set materiality, and
assess acceptable audit
risk and inherent risk
VI. Understand internal
control and assess
control risk
VII. Develop overall
audit plan and
audit program
Dalma P James and Associates

16. I Initial Audit Planning
Should the auditor accept a new client?
Identify why the client wants or needs an audit.
Obtain an understanding with the client.
Select staff for the engagement.
Here we are assuming that the new auditor has done his due diligence and has received a clearance letter from the previous auditor. He now has proof of the identity of the persons behind the entity and all the necessary work which we are now required to do.
The capability and the resources to carry out the assignment (size and location, nature of business, timing, staffing, current commitments);
Independence;
Obtain mere detailed knowledge and information required to plan the audit and an effective approach.
Dalma P James and Associates
Dalma P James and Associates

17. Terms of Engagement
Agreed terms need to be recorded in an audit engagement letter or other form of contract.
Purpose:
To help to avoid misunderstandings between client and auditor.
To confirm:
Auditor’s acceptance of appointment
Objective and scope of audit
Extent of auditor’s responsibilities to the client
Form of any reports
Principal contents:
Objective of the audit
Management’s responsibility
Scope of the audit including reference to applicable legislation and regulations
Form of any reports or other communication of results of the engagement
The fact that there is unavoidable risk of material errors misstatements may remain undiscovered
Unrestricted access to records and information requested
Reference to any further agreements between the auditor and the client
Basis of fees and billing arrangements
Other matters
Audit arrangements
Expectations of receiving from management
Request to confirm engagement
Dalma P James and Associates
Dalma P James and Associates

18. II Understanding of the Client’s Business and Industry
Understand Client’s Business and Industry
Industry and External Environment
Business Operations and Processes
Management and Governance
INDUSTRY AND ECONIMIC FACTORS:
Recession Growth
Interest rates
Source of finance
Inflation
Gov’t policy (monetary fiscal trade ) incentives
Foreign currency rates and controls
INDUSTRY:
Market and competition
Cyclical trade
Technology
Key ratios
Specific accounting practices
Environmental requirements
Regulatory framework
MANAGEMENT AND OWNERSHIP:
Corporate structure
Owners and related parties
Local/foreign
Board of directors
reporting structure and follow-up
Objectives and Strategies
Measurement and Performance
Dalma P James and Associates
Dalma P James and Associates

19. III Understanding of the Client’s Business and Industry
What are some factors that have increased
the importance of understanding the
client’s business and industry?
Information
technology
Global
operations
Human
capital
Dalma P James and Associates
Dalma P James and Associates

20. IV Industry and External Environment
What are some reasons for obtaining an
understanding of the client’s industry
and external environment?
Risks associated
with
specific industries
Unique accounting
requirements
Inherent risks
common to all
clients in certain
industries
Dalma P James and Associates

21. V Business Operations and Processes
Factors the auditor should understand:
– major sources of revenue
– sources of revenue
– key customers and suppliers
– sources of financing
– information about related parties
– ability to obtain financing
Dalma P James and Associates

22. VI Management & Governance
Management establishes the strategies and
processes followed by the client’s business.
Governance includes the client’s organizational
structure, as well as the activities of the board
of directors and the audit committee.
Corporate charter and bylaws
Minutes of meetings

23. VII Client Objectives & Strategies
Strategies are approaches followed by the
entity to achieve organizational objectives.
Auditors should understand client objectives.
Financial
reporting
reliability
Effectiveness
and efficiency
of operations
Compliance
with laws and
regulations
Dalma P James and Associates

24. F. Measurement and Performance
The client’s performance measurement system
includes key performance indicators. Examples:
– market share
– sales per employee
– unit sales growth
– Web site visitors
– same-store sales
– sales/square foot
Performance measurement includes ratio analysis
and benchmarking against key competitors.
Dalma P James and Associates

25. Assess Client Business Risk
Client business risk is the risk that the
client will fail to achieve its objectives.
What is the auditor’s primary concern?
material misstatement of the financial
statements due to client business risk
Dalma P James and Associates

26. The Client’s Business Risk, and Auditor’s Risk Assessment
Industry and External Environment
Understand Client’s
Business and Industry
Business Operations and Processes
Management and Governance
Objectives and Strategies
Assess Client
Business Risk
Measurement and Performance
Assess Risk of
Material Misstatements
Dalma P James and Associates

27. Perform Analytical Procedures
First, analytical procedures use comparison
of client ratios to industry or competitor
benchmarks to provide an indication of the
company’s performance.
Second, analytical procedures use comparisons
and relationships to assess whether account
balances or other data appear reasonable.
Dalma P James and Associates

28. Timing and Purpose of Analytical Procedures
(Required)
Planning Phase
Understand client’s
industry and business
Primary purpose
Assess going concern
Secondary purpose
Indicate possible misstatements
(attention directing)
Primary purpose
Reduce detailed tests
Secondary purpose
Dalma P James and Associates

29. Timing and Purpose of Analytical Procedures
Testing
Phase
Understand client’s
industry and business
Assess going concern
Indicate possible misstatements
(attention directing)
Secondary purpose
Reduce detailed tests
Primary purpose
Dalma P James and Associates

30. Timing and Purpose of Analytical Procedures
(Required)
Completion Phase
Understand client’s
industry and business
Assess going concern
Secondary purpose
Indicate possible misstatements
(attention directing)
Primary purpose
Reduce detailed tests
Dalma P James and Associates

31. Five Major Types of Analytical Procedures
Compare client and industry data.
Compare client data with similar prior-period data.
Compare client data with client-determined expected results.
Compare client data with auditor-determined expected results.
Compare client data with expected results, using nonfinancial data.
Dalma P James and Associates

32. Common Financial Ratios
Short-term debt-paying ability
Liquidity & activity ratios
Ability to meet long-term debt obligations
Profitability ratios
Dalma P James and Associates

33. Short-term Debt-paying Ability
Cash ratio:
(Cash + Marketable securities) ÷ Current liabilities
Quick ratio:
(Cash + Marketable securities
+ Net accounts receivable) ÷ Current liabilities
Current ratio:
Current assets ÷ Current liabilities
Dalma P James and Associates

34. Liquidity Activity Ratios
Accounts receivable turnover:
Net sales ÷ Average gross receivables
Days to collect receivables:
365 days ÷ Accounts receivable turnover
Inventory turnover:
Cost of goods sold ÷ Average inventory
Dalma P James and Associates
Dalma P James and Associates

35. Liquidity Activity Ratios
Days to sell inventory:
365 days ÷ inventory turnover
Dalma P James and Associates

36. Ability to Meet Long-term Debt Obligation
Debt to equity:
Total liabilities ÷ Total equity
Times interest earned:
Operating income ÷ Interest expense
Dalma P James and Associates

37. Profitability Ratios Return on equity:
Net Income ÷ Average (or Total) equity
Return on assets:
Net income ÷ Average total assets
Profit Margin:
Net income ÷ Net Sales
Dalma P James and Associates

38. Summary of Analytical Procedures
They involve the computation of ratios and other
comparisons of recorded amounts to auditor expectations.
They are used in planning to understand
the client’s business and industry.
They are used throughout the audit to identify
possible misstatements, reduce detailed tests,
and to assess going-concern issues.
Dalma P James and Associates

39. Audit Programs
An internal control program contains procedures to obtain an understanding of the client's business and management's control structure, and for assessing the inherent and control risk.
A balance-audit program contains substantive procedures for gathering direct evidence about the seven assertions about dollar amounts in the account balances
Dalma P James and Associates
Dalma P James and Associates

40. Accounting Assertions
In case anyone asks they are as follows:
Existence
Completeness
Occurrence
Valuation (Measurement)
Rights and obligations
Presentation and disclosure
Appropriate carrying value
Dalma P James and Associates
Dalma P James and Associates

41. Summary of the Purposes of Audit Planning
Gain an understanding
of the client’s business and industry.
Assess risks – business risk, inherent risk,
control risk, and acceptable audit risk.
Set materiality and develop overall
audit plan and audit program.
Dalma P James and Associates

42. Audit Approach Test of control systems: Substantive procedures:
Strong controls
Reliance on internal controls supported by
satisfactory results of tests of control
Control is tested not the transaction.
Substantive procedures:
Tests of details of transactions and balances
Analytical procedures
SYSTEMS:
The deviation is where a prescribed control has not been operated effectively whether or not a quantitative error has occurred.
Note:
Reliance cannot be placed on internal controls solely on the preliminary assessment of control risk
If tests of controls disclose no deviation, the extent of substantive procedures may be reduced
If deviations are detected, it may be still possible to restrict substantive procedures. Eg isolated deviation
Most effective for high volumes of individually low transactions.
Substantive procedures alone are likely to be most effective for low volumes of individually high value transactions eg most tangible fixed assets.
Where control risk is deemed to be high the auditor is less likely to rely on a systems approach.
Dalma P James and Associates
Dalma P James and Associates

43. Audit Evidence
ISA 500 demands that audit evidence should meet the following criteria:
Sufficient (Difficulty and expense are not valid reasons for omission)
Appropriate
Relevant
Reliable
Dalma P James and Associates

44. Audit Evidence
Audit evidence is the information obtained by the auditor from which reasonable conclusions can be drawn, as a basis for the audit opinion
Note: The higher the perceived audit risk the higher the level of sudit evidence required to achieve the overall audit objective.
Dalma P James and Associates
Dalma P James and Associates

45. Gathering Audit Evidence
Selection Methods:
Any one or a combination of:
Selecting all items
Selecting specific items
Audit sampling
Risk considerations
Inherent , control and detection risk
Sampling and non-sampling risk
Professional judgment should be used to:
assess audit risk
design audit procedures
To reduce audit risk to an acceptable low level.
Dalma P James and Associates
Dalma P James and Associates

46. Selecting All Items
Population consists of a small number of large value items
Items to which nonmonetary materiality does not apply
Unusual one-off or exceptional items
Any area where the auditor is put on enquiry
Exceptionally risky areas
When the repetitive nature of a CIS operation makes 100% examination cost effective.
Normally used in substantive tests. Costly, time consuming, level of accuracy not required, tedium,
Does not all value.
Dalma P James and Associates
Dalma P James and Associates

47. Audit Sampling Judgmental selection: Advantage: Disadvantage:
Knowledge of business
Preliminary assessment of inherent and control risk
Characteristics of the population
Advantage:
Usually efficient means of gathering evidence
Disadvantage:
Not statistical. Cannot project results to population
High value or key items
All items over a certain amount
Items to obtain information
Items to test procedures
Dalma P James and Associates
Dalma P James and Associates

48. Audit Sampling
Items should be selected in such a way that all sampling units have a chance of selection. For statistical sampling the sampling items must be randomly selected. computer generated random numbers or random number tables must be used. Systemic selection – set interval with random start.
Haphazard
Block
These may be used but have their limitations.
These considerations can have profound effects on the conduct of an audit therefore should not be left to junior staff, but should be dome by senior audit staff at the planning stage.
Dalma P James and Associates
Dalma P James and Associates

49. The Audit Plan At this stage you should have: Assessed the audit risk;
Devised a programme to efficiently minimize the audit risk;
Documented the clients systems and your assessment of them;
documented/tailored the audit programme;
Prepare junior staff for the assignment.
Dalma P James and Associates

50. Thank You Dalma James Dalma P James and Associates
2b West Ivy Green Crescent
Kingston 5
Phone: Fax:
Dalma P James and Associates