FINANCIAL AUDIT METHODOLOGY PETER CARLILL UK NATIONAL AUDIT OFFICE

FINANCIAL AUDIT METHODOLOGY

PETER CARLILL

UK NATIONAL AUDIT OFFICE

ROLE OF NAO

• To provide independent information, assurance and advice to Parliament on the use of public resources

• To help promote better financial management and value for money

Our role

BODIES AUDITED

• C&AG audits: 600+ financial statements covering £456 billion

• Revenue of £337 billion

• Assets worth £203 billion

• Long term\liabilities of £37 billion

FINANCIAL AUDIT

• Audit Opinions

• Reports on Accounts

• Advice and guidance

PERFORMANCE AUDIT

• How well Government policy is delivered

• In particular:

– Economy

– Efficiency

– Effectiveness

IMPACT

• Savings of over £8 every £1 spent by the NAO

• £1.4 BILLION saved over the last three years

• Over 90 PER CENT of PAC recommendations

accepted

WHY HAVE A METHODOLOGY?

• Ensures Auditing Standards are applied

• Ensures consistency across the NAO (600+ accounts)

• Helps achieve a quantifiable level of assurance (95% confidence level)

UNDERSTANDING THE BUSINESS

AUDITING STANDARD• In performing an audit of financial

statements, the auditor should have or obtain a knowledge of the business sufficient to enable the auditor to identify and understand the events, transactions and practices that, in the auditor’s’ judgement, may have a significant effect on the financial statements.

UNDERSTANDING THE BUSINESS

THREE AREAS TO CONSIDER:

• Ministry’s external environment

• Legislative framework

• Overall control environment within the Ministry

UNDERSTANDING THE BUSINESS

AUDITING STANDARD

• The auditor should apply analytical procedures at the planning stage to assist in understanding the business and in identifying areas of potential risk.

MATERIALITY

AUDITING STANDARD

• Materiality should be considered by the auditor when: a) determining the nature, timing and extent of audit procedures and b) evaluating the effect of misstatements

MATERIALITY

An audit needs to be planned and conducted so as to provide reasonable assurance that the financial statements are free from material misstatement.

A matter is considered material if its omission, concealment or misstatement could influence the decisions of users of the financial statements that were taken on the basis of the financial statements.

MATERIALITY

Usually a percentage (0.5% - 2%) of:

• Gross Assets

• Gross Expenditure

• Income

Or, if applicable:

• Profit (5-10%)

MATERIALITY

BUT:

Some items can be material because of their sensitivity or by their context, even though they may be small in value.

USE OF MATERIALITY

• Determines our audit approach to different account areas

• Helps us conclude on the extent of errors found

IDENTIFY MATERIAL RISKS

• Normal risk is present where transactions are systematically processed, where the management and control environment is good and where the nature of the transactions themselves does not lead to an increased risk of error. In case of normal risk we can reduce the scope of audit procedures;

• High risk is present in any account area where the above characteristics do not apply. In case of high risk, we take all the assurance we require from substantive and controls testing.

RISKS

• ENTITY RISK

• ACCOUNT AREA RISK

RISKS

Plot on the Risk Mapping Diagram:1. Computer crash leading to loss of all

accounting records2. Failure to estimate useful lives of PCs

leading to incorrect depreciation charges3. Risk of error in social security payments

because of highly complex regulations and frequent changes of staff (Ministry’s only activity)

AREAS OF HIGH RISK

• DETERMINE MINISTRY’S RESPONSE TO THE RISK (IN TERMS OF ADDITIONAL CONTROLS OR SUPERVISION)

• ASSESS THE RESIDUAL RISK AND AUDIT PROCEDURES PROPOSED IN RESPONSE

AUDIT PROCEDURES:

CONCEPT AND DECISION TREE

9

The Decision Tree

The Decision Tree provides a framework to determine the audit procedures to be used for each area of the account.

The starting point is our assessment of risk for the entity as a whole and for individual account areas. Where we have identified risks of material misstatement we should look to test controls that have been identified as mitigating the risks. Where we have identified no risks of material misstatement we should still look to test controls relevant to the account area to provide the majority of audit assurance.

Beyond controls testing the balance of assurance will come from substantive procedures, including analytical procedures (AP’s).

* If the account area/balance being audited is not material it may be sufficient to rely on an overall review of outtum only, without testing controls.

UNDERTAKING THE AUDIT

• ANALYTICAL PROCEDURES

• RELINCE ON OTHERS

• CONTROLS TESTING

• TRANSACTION TESTING

ANALTYCIAL PROCEDURES

• COMPARATIVE

• PREDICTIVE TEST/MODELLING

RELIANCE

• INTERNAL AUDIT

• OTHER AUDITORS

• OTHER SPECIALISTS (eg BUILDING VALUATIONS)

ASSURANCE FROM CONTROLS

AUDITING STANDARDS• The auditor, in determining the extent and

scope of the audit, should study and evaluate the reliability of internal controls.

• The auditor should obtain an understanding of the accounting and internal control systems sufficient to plan the audit and develop an effective audit approach.

CONTROLS

HIGH LEVEL controls are those which affect > 1 transaction. For example:

• Reconciliations

• Regular monitoring

• Exception reports

CONTROLS

Assurance through:

• Re-performance

• Examination

• Enquiry

• Observation

TRANSACTION TESTING

Transaction testing is expensive, therefore use other methods first to reduce the numbers required.

Can use:• Statistical sampling• Stratified sampling• Judgemental samplingBut beware of sample sizes too low or too

high

EVALUATE RESULTS

• Errors < materiality

• Errors> materiality

REPORT RESULTS