Lecture - 5 - Auditing and Accounting

8/3/2019 Lecture - 5 - Auditing and Accounting

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FADM 2

CA.N.Nabeel Ahmed B.com, ACA, CMA, AICWA, MBA


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Auditing

yNeed for audit

y Objective of the audit

y Regulatory requirements for audit by Companies Act


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Need for Audit

Shareholders Directors

Auditor

Information asymmetry

and conflict of interest leadto information risk for the Shareholders

Shareholders - provides capital

and hires manager

to manage it.

Directors hires auditor toreport on the fairness ofmanager financialstatements. Riskinformation asymmetry ofprinciple reduce.

Auditor gathersevidence to evaluatefairness of managerfinancial statements.

Director is accountable to Shareholders;provides financial reports.


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Objective of Audit

The objective of the audit is to express an opinion on

the financial statements whether or not the financial

statements present fairly.

1) Unqualified Report Clean Report

2) Qualified Report

3) Disclaimer Report


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Regulatory RequirementSection XX of companies act:

The balance-sheet and the profit and loss account shallbe audited by theauditor of the company, in the manner hereinafter provided, and theauditors report shall be attached thereto.

Section XX of companies act:

Every auditor of a holding company appointed shall also report onconsolidated financial statements and exercise all such powers and duties asare vested in him.

Section XX of Companies Act:Every company shall at each annual general meeting appoint an auditor orauditors to hold office from the conclusion of that meeting until theconclusion of the next annual general meeting.


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TYPES OF AUDITSy Financial statements audits

y Compliance audits

y Operational auditsy Forensic audits

y IT audits


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THREE FUNDAMENTAL CONCEPTS

IN CONDUCTING AN AUDIT

yMateriality

yAudit riskyEvidence


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MATERIALITYAn aggregate of all misstatements in financial statements

is considered to be material if,

in light of surrounding circumstances,

it is probable that the decision of a person who is relying othe financial statements,

would be influenced by the aggregate of all misstatements.


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AUDIT RISKAudit risk is the risk that the auditor will fail toexpress a reservation in his or her opinion on

financial statements that are materialitymisstated.


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EVIDENCEy Evidential matter supporting the financial statements

consists of the underlying accounting records.

y It should be relevant and Reliable

y Relevance refers to whether the evidence relates to thespecific audit objective being tested.

y Reliabilityrefers to the whether or not a particular typeof evidence can be relied upon to signal the true state ofthe assertion or audit objective.


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THE AUDITOR'S STANDARD

UNQUALIFIED AUDIT REPORTy This is the most common type of audit report.

y The standard unqualified audit report contains

seven important elements:y Title

y Addressee

y Introductory paragraph

y Scope paragraph

y Opinion paragraph

y Name of auditor

y Date of report


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FinancialStatements

THE RELATIONSHIP OF EVIDENTIAL MATTER TO THEAUDIT REPORT

AccountingRecords

ManagementAssertions

Audit

Procedures

AuditReport

Evidence


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SAMPLING: INFERENCES BASED

ON LIMITED OBSERVATIONSy Due to cost and time constraints, the auditor

examines only a subset of the data (transactions)

available in the clients records.yAs a result, the auditor uses his/her knowledge about

the transactions and/or a sampling approach toexamine the transactions.


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Will an Auditor be always liable for

wrong opinion?y The phrase true and fair in the auditor's report signifies that the

auditor is required to express his opinion as to whether the assets andliabilities represent a true position.

y In specific terms to ensure truth and fairness, an auditor has to see:

y that the assets and liabilities are neither undervalued or overvalued;

y the charge on assets, if any, is disclosed;

y accounting policies have been followed consistently;

y all unusual, exceptional, non recurring items have been disclosedseparately;

y accounts have been drawn as per requirement of accounting standards


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OVERVIEW OF THE AUDIT PROCESS

y Client acceptance and continuance

y Establish the terms of the engagement

y Plan the audit

y Consider internal control

y Conduct audit procedures

y

Complete the audity Issue audit report


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Auditof Income Statement Itemsy Rent Received

y Cash Sales

yAssets received on Hirey Sale ofScrap


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Cash Salesy i) Examine the systemofinternal controlto ascertain any

loopholes therein.

y (ii) Ensure thatthe date of cash memos tally with the

entry in the cash account.y (iii) Verify thatprices of goods sold have been correctly

recorded and check the calculation.

y (iv) Verify the entry in the goods outward book with the

sales account.


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Rent Receivedy (i) Check copies of rent receipt issued to the tenant with

reference to tenancy agreement

y (ii) The entries in the rental register in respect of rent accruedshould be traced with reference to copies of rental bills.

y (iii) Scrutinize the account of collecting agent when the rent iscollected by such agent.

y (iv) Vouch the entries for rent received in advance and ensureproper adjustment is made.

y (v) Investigate into abnormal rent outstanding.

y (vi) Reconcile the outstanding rent and see that proper provisionis made if unrecoverable


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Assets received on Hirey (i) Inspectthe agreementto ascertain the terms and

condition, the installment.

y (ii) Ensure thatthese are nottreated as an asseton balance

sheetifitis an operating lease.


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Sale of Scrapy (i) Review the internal control as regards disposal of scrap.

y (ii) Check whether the organization is maintaining reasonable recordfor generation ofScrap.

y (iii) Analyze the raw material used, production and generation patternof scrap and compare the same with figures of earlier year.

y (iv) Check the rates at which scrap has been sold and compare the ratewith previous year.

y

(v) Vouch sales, with invoices raised, advertisement for tender, ratecontract with scrap dealers.

y (vi) Ensure that there exists a proper control procedure to identifyscrap and good units and they are not mixed up and sold as scrap.


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Auditof Balance Sheetsy Creditors

y Borrowings for a Bank

y Inventoryy Plant and Machinery


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Creditors ( Accounts Payable )

y (i) Compare the balances with the confirmation or statementofaccountreceived fromtrade creditors.

y (ii) Pay special attention tolong outstanding items and enquireaboutthe reason thereof.

y (iII) Verify subsequentpayments and reversal entries in the

Purchases ledgerof year end entries.

y (Iv) See thattrade creditors are classified and shown in thebalance sheet as perrequirementof Accounting Standards.


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Borrowings from a Banky Ensure that balance as per books ofthe COMPANY and the

BANK statementtally. In case of difference between the twoamounts, reconciliation statementprepared by the clientshould account forreasons.

yExamine whether borrowings fromthe bank have been dulyauthorized.

y Examine the loan agreement and ensure thatthe termstherein have been duly complied with.

y Ascertain the purpose forwhich loan has been raised andexamine whether end use ofthe funds have been accordinglymade.


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Inventoryy Physical Verification of stock as on end of the

accounting period.

y

Track internal control for purchases of stock.yValuation at year end lower of cost or MV.

y Check ageing analysis for stock to verify expired items

y Track internal control for sales of stock

y Scrap items should be separately stored


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Plant and Machineryy Physical verification of Assets on sampling basis.

y Ensure that depreciation is calculated correctly for the

accounting period.y Ensure the profit on sale of assets has been recorded

an extra ordinary item and not as regular sale.

y Ensure Capital expenses had been duly capitalized.

Documents

Lecture - 5 - Auditing and Accounting