ACCOUNTANCY FORM SIX TOPIC 10:AUDITING

 

 TOPIC 10: AUDITING

Meaning of Auditing

An Audit – may be defined as an examination by an Auditor of the final accounts i.e. trading account, profit and loss account and Balance sheet of a business enterprise.

→Also it involves the checking of supporting documents from which these accounts are prepared.

→The main purpose of an Audit is to ascertain whether or not these accounts present a True and fair view of the financial position of a Business.

IAG3 Has defined Audit as under ;- Audit is an Independent examination of an expression of an opinion on, the financial statements of an entity, by an appointed Auditor in pursuance of that appointment and in compliance with any relevant statutory or other provision including in particular Tanzania statements of standard Accounting practice .(TSSAP’S.) Together with relevant Auditing standards and Guidelines.

Auditor; The word Auditor comes from Latin word ‘Audire’ which means to hear.

Is the one whom the Receipts and payments of an establishment were read and he was supposed to hear ‘or is an Independent person who is appointed by business enterprises to audit its accounts. The auditor may be an individual or a firm.

The Auditor’s Duty is to form an opinion and report on the financial statements of a business enterprise for a specific period.

Auditing; Is the process of examination of financial statement’s covering the transactions over a period of an organization on a certain date in order that the auditor may issue a report on them.

→It means Auditing is the Application of Auditing principles.

TYPES OF AUDITING

The following are the types of Auditing;

Statutory Auditing

Are those which are conducted under the provisions of the law of the country, According to companies Act of Tanzania all limited companies are required to get their accounts Audited, Similarly, co-operative societies Banks, Insurance companies and financial institutions are also required to get their accounts audited according to the provisions of respective Acts.
Private Audit

Private or voluntary Audit is that audit which is not legally required. Examples of private audit are audits of sole trader, partnership business and Management audit of a limited company.
Internal Audit

Internal Audit is conducted by the internal auditor who is an employee of an organization.

→ the main purpose of internal audit is to find out whether the internal control system is working successfully or not.

→The report of internal audit is used only by the management for the improvement of internal control system. The internal auditor carries out checking work throughout the year

→Although, he is an employee of the organization but he is given some form of Independence in order to perform his duties more efficiently.
External Audit

External Audit is carried out by an Independent Auditor who is not an employee of the organization

→Internal auditor is appointed by the owners of a business. In case of a e the limited company, the share-holders appoint an external auditor.

→The main purpose of an external auditor is to submit an audit report on the financial position of business enterprises.

The Report is accepted by the share holders and other concerned parties like Bank managers, creditors.

Procedural Audit;

1. Is an examination and Review of the internal procedures and records of an organization. The main purpose of this audit is to ascertain whether the internal procedures are reliable or not.

→The procedural audit is conducted in order to improve the efficiency of internal control system and to ensure the implementation of the procedures/laid down by the management

→Also the procedural Audit is very expensive but can be applied where the owners suspect the duplication of internal policies followed by the directors.

Management Audit

Management Audit is conducted to investigate the management aspects of a business

→The main purpose of this Audit is to prepare of report on the effectiveness of the management from the point of view of the profitability and efficient running of the business.

→This Audit can reveal strengths and weakness of the management.

Standard Audit

This is a type of audit which is conducted to ascertain whether the client accounting system complies with the required levels of standards set by the professional bodies

1. Tanzania statement of standard Accounting practices (SSAP’S)U.K
2. International Accounting standards (IAS)
3. General Accepted Accounting principle (GAAP’s)

Continuous Audit/Detailed Audit

Is an Audit which involves regular intervals of say one or three months

→The Auditor visits his clients at regular or irregular interval during the financial year and checks each and every transactions

Balance sheet Audit

Verification of the values of Assets, liabilities, the balance of reserves and provisions and the amount of profit earned or loss incurred by a firm during a year.

→This audit requires the auditor to report only on the balance sheet. In this case, he cannot ascertain whether the accounts supporting the balance sheet are kept or not.

→This type of Audit is more popular in USA and CANADA and is not common in UK and other countries including East Africa countries.

→ With Development of Industries and establishment of large companies, this type of Audit will be more widely used in the future.
Vouching Audit

Vouching Audit is that Audit where the auditor checks each and every transaction right from the origin in the books of prime entry till they are posted and the final accounts are prepared from the amount posted.

→This Audit requires lot of work.

→This system has become unpopular in large organizations where the numbers of transactions are into millions and where a good internal control system is in use. These days, the auditor relies on the examination of some of the transactions scientifically selected at Random. In UK, Kenya and other East African countries vouching audit is common approach.
Government Audit

Is the audit conduct in government Authorities, ministries departments by the controlled Auditor General(CAG) according to the Exchequer and Audit ordinance or act.

Note; It is the audit required by the government and it is conducted by controller and Auditor general (CAG) as per Audit act and Exchequer ordinance.

Financial Audit

Is the audit conducted to verify the accuracy of financial statements only and creating an opinion whether or not the financial statements portray the fair and true view of the firm’s financial position & operation results. Note it is mostly conducted by External Auditor who is Independent in his opinion.

Final Audit;

1. Is the Audit conducted and carried out at the end of the financial year and normally after the preparation of financial statements

ADVANTAGES OF FINAL AUDIT

1. Reduce chances of changing figures in the books of final Account
2. It is less expensive and suitable for small business
3. It is convenient to the client staff
4. The work of auditing becomes chemical easy.

DISADVANTAGES OF FINAL AUDIT

1. Not suitable (Advisable) to large entities
2. Delays in Auditors report due to short period (time of Auditing)
3. Large possibilities of errors and frauds even after audit process

INTERIM AUDIT

Is the  audit conducted and carried out before the end of the year normally between the accounting periods.

NOTE; If it is undertaken to cover certain in dates within the financial year(trading period) e.g. quarterly &s of half yearly. Mainly for determining amount of profit to enable the company to declare an interim dividend to be distributed to shareholders.

ADVANTAGES INTERIM AUDIT

1. It makes easier the audit work at the end of the financial year
2. Easy to determine errors and frauds
3. Final audit can be completed very soon.

DISADVANTAGES OF INTERIM AUDIT

1. Figures may be altered after and it works.
2. Inconvenient to the client staff.
3. Additional work.

Partial Audit

Is the audit conducted only for specific or particular purpose on the instructions of the owner (client).

O.) Complete Audit

This is the Audit conducted and carried out by examining every transactions of the firm through checking of all vouchers, documents, financial statements, letters and minutes in details. This Audit is suitable for the firms with very weak internal control systems.

Note; These various types of Audit can be classified according to;-

1. Form of organization

Under this class, various types of audit are;-

1. Audit of accounts of a sole proprietor
2. Audit of partnership accounts
3. Audit of accounts of limited companies
4. Audit of Government accounts
5. Other institutions

Nature of work

Various types of audit are, but according to the

1. Private audit
2. Statutory audit
3. Internal audit
4. External audit

Time factor

Audit may be conducted at different intervals of time. These are;

1. Final Audit
2. Interim Audit
3. Continuous Audit

Method of approach

According to method of approach, various types of audit are;

1. Procedural audit
2. Management audit
3. Standard audit
4. Balance sheet audit
5. Vouching audit

OBJECTIVES OF AUDITING

These objectives of an Audit may be classified as under;-

1. Primary objectives
2. Secondary or subsidiary objectives

PRIMARY OBJECTIVES

The primary objective of an Audit is to enable the auditor to determine the accuracy of financial statements or accounts.

The auditor forms his opinion through an audit whether or not the final account show a True and a fair view of the financial position of a business.

If the Auditor is of the opinion that profit and loss account and the balance sheet give a true and fair view of financial position of business enterprises then any reading and using primary objective of auditing are contained in the company act. These are known as statutory objectives. These include;

1. The auditor has an obligation to prove the true and fair view or other wise of the company’s financial state of affairs
2. He should confirm the proper books of accounts are being kept or not.
3. The auditor is required to communicate his findings to the shareholders of the company in form of a report together with his opinion.

SECONDARY OBJECTIVES

These secondary or subsidiary objectives of auditing are;-

1. To detect errors and fraud

Errors and frauds can be ascertained and detected by the management through the established internal control system.

1. To prevent errors and fraud i.e. through internal control system
2. To assist the clients to improve their accounting system
3. To find out whether the internal control system is working properly or not.

It must be emphasized that it is not the auditor duty to discover frauds but if he comes across them during the audit he should point out these frauds to the concerns persons. He should also point out the errors.

FUNCTIONS OF AUDITING

1. Studying the Accounting system

It is the basic function of Auditing in order to determine the nature, timing and extent of the audit procedures. Auditor should know the accounting systems.

1. Internal control system

It is the process which determines that management policies are carried out according to the accounting system. This system is very useful to safeguard the interest of enterprises. The Auditor determines the effectiveness of this system.

1. Vouching

This is to determine the accuracy of the accounting of the assets of the business. The auditor can check the existence of asset.

1. Legal requirement;

It is the function of auditing that statement is prepared under the legal requirement and various laws like company with Income tax ordinance which are introduced by the Government.

1. Liabilities verification

The liabilities can be verified from the books of accounts. The auditor can write letter to a creditor for the verification of liabilities. The auditor receives the certificate from management.

1. Capital and revenue

Auditing should make difference between capital and revenue items. The capital items are compared to note the financial position of the business. The revenue item is compared to determine the Income. The years Income and expenses related to many can divide in correct and coming years.

1. Valuation of liabilities

Through Auditing the value of liabilities and auditor can apply the accounting principles to assess the value of liabilities. The Auditor critically examines and takes help from the expert

1. Valuation of assets

The management gives the value of assets and Auditor can apply the accounting principle to assess the value of assets. The Auditor critically examines and takes help from the experts.

INTERNAL CONTROL

The whole system of controls, financial and otherwise established by the management in order to carry on the business of the enterprise in an orderly and efficient manner, safeguard the assets and secure as far as possible the completeness and occurrence of the records.

The individual components of an internal control system are known as ‘controls’ or Internal control various types of Internal control are;

1. Control on purchases and creditors
2. Control on stock and work in progress.
3. Control on cash receipts and payments
4. Control on wages payments
5. Control on sales and debtors
6. Other controls

DETAILED INTERNAL CONTROL OBJECTIVES

An attempt is made here to systematize the various internal control objectives independent of the type of the client’s business. The Internal controls over the accounting system should be designed to ensure that the following seven objectives are achieved

1. Validity – The internal control system should be designed to ensure that recorded transactions are valid. The system should not permit the inclusion of fictitious or nonexistent transactions in the records.
2. Authorization – The system should be designed to ensure that recorded transactions are authorized. An unauthorized transaction is a fraudulent one and leads to resources wastage.
3. Completeness – The set procedures must ensure that existing transactions are recorded to prevent omission from the records.
4. Valuation – An adequate internal control system most include procedures to avoid errors in arriving at values of the transaction amounts in the recording process
5. Classification – The laid procedures must ensure that proper classification of accounts is made if the financial statements are to be properly stated
6. Timing – Procedures in the internal control system should ensure that transactions are recorded at proper time’s i.e. not before or delayed as this may lead to mis – statement.
7. Posting and summarization – The internal control system procedures have to be designed should ensure that transaction  properly recorded and included in the subsidiary records these are follows;

1. To promote operational efficiency – The control within an organization are meant to prevent unnecessary duplication of effort and waste in all aspects of the business and to discourage inefficient use of other resources.
2. To encourage adherence to prescribe policies – Management Institutes procedures and rules in order to meet goals of the entity. The internal control system is meant to provide assurance that the policies are as followed by the clients’ personnel.
3. To safeguard the Assets – This relates to physical as well as non- physical assets which can be stolen, misused, accidentally destroyed unless they are protected by adequate control
4. To provide reliable data – Management must have accurate and reliable information as the basis for its future decisions and also for carrying out its operation.

INTERNAL AUDIT

Internal audit – as an independent appraisal function established by the management of an organization for the review of the internal control system as a service to the management.

The main objective of Internal Audit is as under;

1. To safeguard the company’s Fixed assets
2. To assist the management as far as possible to run the business efficiently and in orderly manner.
3. To act as a consulting department to other departments
4. To detect and prevent errors and frauds perpetrated by the client staff.
5. To help in the maintenance of a strong internal control system employed by the client.
6. To help the client to reduce the audit fee of the internal auditor.

EXTERNAL AUDIT

Is the audit conducted within the organization by an independent appointed auditor from outside the organization who is recognized by NBAA. External auditor is appointed by the owner of the firm and not the management of the firm in case of limited company the share holders appointed the internal auditor.

The main objective (primary objective) of external audit is to determine the accuracy of financial statements or accounts and form a true and fair view of the financial position and operation result of the business.

Other objective under external audit is as follows;

1. To confirm whether or not the proper books of accounts are kept
2. Detection of errors and frauds
3. Present findings to the owner in a report together with his opinion (auditing opinion)
4. Assist its client to improve their accounting system i.e. vouching and internal control system.
5. Finding out the weakness or strength of internal control system.

IMPORTANCE/SIGNIFICANCE OF INTERNAL AND EXTERNAL AUDIT.

1. It helps to determine the effectiveness of internal control system
2. It cuts down the work of external auditor and as a result the audit cost of external auditor reduces
3. It helps to prevent frauds
4. It facilitates the maintenance of proper accounting records and preparation of financial statement s in time.
5. It helps to review of the implementation of corporate policies, plans and procedures.
6. It helps to examine of financial and operating information for management detailed of transactions and balances.
7. Special investigations

SIMILARITIES BETWEEN INTERNAL AND EXTERNAL AUDIT

1. Both ensure the operation of an effective system of Internal control system
2. Both use almost similar techniques to conduct audit
3. Both safeguard the assets of the company
4. Both follow the professional ethics in the conduct of Audit.

DIFFERENCES BETWEEN INTERNAL AND EXTERNAL AUDIT

INTERNAL AUDIT	EXTERNAL AUDIT
Is conducted by the internal auditor who is an employee of an organization	Is an audit which carried out by an independent auditor who is not an employee of the organization
The main objective is to find out whether the internal control system is working successfully or not.	The main objective is to determine the accuracy of financial statement or accounts and form an independent opinion or whether or not financial statements show true and fair view of all financial position and operation.

AUDITOR’S  WORKING PAPER

Nature and definition

Introduction – The efficiency of the Audit work is enhanced through the careful compilation and maintenance of audit work performed documentation of audit work is done through preparation of Audit working papers. Working papers

Meaning;

Working papers – are the records kept by auditor of procedures applied, tests performed, evidence (information) gathered and the pertinent conclusions reached in the audit engagement

→Audit working papers should be prepared as the audit proceeds so that the details and problems are not omitted.

→Each audit working paper should be properly identified with information such as client’s name, period covered, description of contents, initials of the person who prepared it, date and an index code.

FORMS/TYPES OF AUDITOR’S WORKING PAPER

Audit working papers are classified into two categories and each category assembled in a separate file. This division into the two types is a matter of convenience to the auditor and there is no guideline on it. These are as follows;

1. Permanent Audit.}   For the same client
2. Current Audit file.}

A.PERMANENT AUDIT FILE                                                                                 

A permanent Audit file is essential to the auditor in a continuous nature and which will be of value to each successive audit

→The file acts as a constant source of reference and helps avoid asking the client the same questions every time the auditor commences the annual audit. The permanent audit file typically contains the following;

• Memoranda and Articles of association and other appropriate statutory or legal regulations
• Copies of evidencing important agreements entered by the client e.g. leases, debenture deeds and other major contracts
• Brief description of the type of business
• Details of physical location of a business e.g. Factories, offices, shops etc.
• Details of the client’s accounting system and internal audit procedures
• An organization chart of the client’s staff.
• Name and address of client’s Advisers, including bankers, stock brokers and management statement showing important accounting matters such as history and reserves, adopted basis of accounting e.g. stock valuation department
• Lists of accounting records and responsible officials

Note; Permanent Audit files should be updated at appropriate

1. CURRENT AUDIT FILE

The current audit file is used to hold all the working papers applicable to the year under audit. It should normally contain the following;

1. A copy of the statement on which the auditors are reporting authenticated by the directors signatures
2. An index covering all working papers unless they are cross-referenced to the relevant items in the accounts.
3. Audit program
4. An internal control questionnaire and other records including flow chart if designed to record and ascertain the adequacy of the internal control system
5. A schedule for each item on the balance sheet including comparative figures, showing its makeup, existence ownership
6. A schedule supporting each item in the statutory profit and loss account including comparative figures.
7. Checklist concerning compliance with statutory disclosure provisions
8. Record of queries and their manner of disposal including notes for future attention if necessary
9. A schedule of the important statistic or working ratios, comparative figures included where appropriate.
10. A record or extract of minutes of meetings of the directors and shareholders. These should be cross- retraced where relevant to the other working papers
11. Copies of letters to clients setting out any material weaknesses or matters with which the auditors are dissatisfied regarding the accounts or control procedures.
12. Letter representation

Note; matters not of permanent importance, but which will require attention during the subsequent year’s audit should be listed with references to the relevant working paper and a note transferred to the next current file while opened.

AUDIT REPORT AND OPINION
Audit report: Is a report prepared by an independent auditor to the management after examining the company’s financial statements. It includes the auditors opinion regarding the true and fair view of the company’s financial statement representation.
Audit opinion: This is the view given as a recommendation by an auditor after auditing the company’s financial statement.

TYPES OF AUDIT OPINION
1.Unqualified opinion
This is given when the auditor is satisfied with the presentation of the company’s financial statement, i.e the company’s financial statement shows the true and fair view. The company’s financial statement is prepared with the compliance of international accounting standards.

2.Qualified opinion
Given when an auditor fail to give out his or her opinion regarding the true and fair view of company’s financial statement. Some of the items in the financial statement are not presented in the way in which they are supposed to be presented.

3. Disclaimer opinion
Given when there is the limitation of scope i.e If the management limit an auditor to audit some of the documents or to do physical stock of the company’s assets as a part of audit sampling.

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