CHAPTER I
GENERAL INFORMATION
Attention:
Students have to bring F4 size notebook to do all the tasks in this
subject.
1.
THE OBJECTIVE OF THE FINANCIAL STATEMENTS AUDIT
To test the fairness of the financial statement presentation. The criterion for
the fair presentation of the financial statements are:
a. The conformity of the statements with the underlying supporting
evidences, which are consist of source documents (such as invoices, cash
receipt etc.) and accounting records (such as journal, subsidiary ledger,
and general ledger), and
b. The conformity of the statements with the aplicable accounting standards.
c. To detect the possible errors or fraud in the financial statements. Error is
unintentional mistake whereas fraud is intentional mistake, either being
commited by individual or by business.
2.
AUDIT PROCESS
a.
Accepting the audit engagement
b.
Preparing the engagement letter
c.
Understanding industry of the client business, to see the characteristics
of the business transactions, the financial statements, as well as to see
the business trend of the industry.
d.
Understanding the client business, to see the characteristics of the
transactions in the client business as well as the characteristics of the
clients financial statements.
e.
Understanding the ICS (Internal Control Structure) in the client business,
to see the control systems in the client business, to mitigate the potential
error and fraud.
f.
Tests of control, to measure the sufficiency of the ICS, the effectiveness
of the ICS, and the level of control risk (remember the types of risk:
inherent risk, control risk, detection risk, and audit risk).
g.
Substantive tests, to measure the fair presentation of the management
assertion in the elements of the financial statements.
h.
Completing the audit process.
i.
Formulating the auditor opinion to the audited financial statements.
j.
Discussing with the client about matters related to the audit process and
audit result.
k.
Drafting the auditor report.
Remember:
Most of audit tests being conducted base on sample tests, and consists of
tests of control and substantive tests.
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3.
ENGAGEMENT LETTER
Example of an Audit Engagement Letter
The following letter is for use as a guide in conjunction with the considerations
outlined in this ISA and will need to be varied according to individual requirements
and circumstances.
To the Board of Directors or the appropriate representative of senior management:
You have requested that we audit the balance sheet of ..................... as of ...............,
and the related statements of income and cash flows for the year then ending. We
are pleased to confirm our acceptance and our understanding of this engagement by
means of this letter. Our audit will be made with the objective of our expressing an
opinion on the financial statements.
We will conduct our audit in accordance with International Standards on Auditing (or
refer to relevant national standards or practices). Those Standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatements. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation.
Because of the test nature and other inherent limitations of an audit, together with
the inherent limitations of any accounting and internal control system, there is an
unavoidable risk that even some material misstatements may remain undiscovered.
In addition to our report on the financial statements, we expect to provide you with a
separate letter concerning any material weaknesses in accounting and internal
control systems which come to our notice.
We remind you that the responsibility for the preparation of financial statements
including adequate disclosure is that of the management of the company. This
includes the maintenance of adequate accounting records and internal controls, the
selection and application of accounting policies, and the safeguarding of the assets
of the company.
As part of our audit process, we will request from management written confirmation
concerning representations made to us in connection with the audit.
We look forward to full cooperation with your staff and we trust that they will make
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available to us whatever records, documentation and other information are
requested in connection with our audit. Our fees, which will be billed as work
progresses, are based on the time required by the individuals assigned to the
engagement plus out-of-pocket expenses. Individual hourly rates vary according to
the degree of responsibility involved and the experience and skill required.
This letter will be effective for future years unless it is terminated, amended or
superseded.
Please sign and return the attached copy of this letter to indicate that it is in
accordance with your understanding of the arrangements for our audit of the
financial statements.
Acknowledged on behalf of ABC Company by
(signed)
......................
Name and Title
Date
Students Task
Use your F4 size notebook:
1.1. Give short description about the objectives of the engagement letter
1.2. Rewrite the above example of the financial statements audit engagement letter
1.3. Give short explanation about the main message in each of the paragraph of the
engagement letter
4.
TRANSACTION CYCLES
Financial statements are the statements of the financial effects of the tansactions that occure
in a business organization, that consists of the following main group of transactions, which
are named as transaction cycles:
a.
Financing cycle, related to transactions of fund rising, i.e. through bank loan, issuing
bond, and issuing stock.
b.
Investing in fixed asset cycle, related to transaction of purchasing fixed assets
c.
Operating cycle
1.
Expenditures cycle, related to obtaining resources to support operational
activitites.
2.
Human resource cycle, related to expenditurs for human resources, from
recruitment until retirement.
3.
Conversion/production cycle, related to producing goods or services for sales.
4.
Revenues cycle, related to selling goods or services, either cash sales or credit
sales.
d.
Investing in financial instruments cycle, related to transactions of investing the excess
of cash in bonds or stocks of other companies.
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Transactions in all of the above cycle will always relate to cash balance, either directly or
indirectly.
Students Task
Use your F4 size notebook:
1.4. Give at least two examples of transaction in each of the above transaction cycle, as well
as the journal entry for each of the transaction which is used as an example.
5.
CONTROL PROCEDURES AND TESTS OF CONTROL
To mitigate the potential errors (unintentional mistake) and fraud (intentional mistake),
company have to implement control procedures. Auditor have to understand and tests the
control existence of control procedures to assess the level of risk of errors as well as risk of
fraud.
5.1. The Type of Control Procedures
5.1.1. General Control
a.
b.
Segregation of functions, to minimize incompatible functions
Access control to assets and information, to provide proper safeguarding of assets and
records by restricting access only to authorized personnel.
5.1.2. Specific or Application Control
a.
b.
c.
d.
Authorization, to ensure that transactions are executed in accordance with required
authorization, either general or specific authorization, and to ensure that only valid
transactions are processed. General authorization is authorization to engage certain day
to day operation, and specific authorization is authorization to engage specific
transaction.
Input controls, to ensure that all transactions that should be recorded in the accounts
are recorded in the correct amounts and are posted to the appropriate accounts. Includes
numerical sequencing and control of documents, and control totals.
Processing controls, to ensure that input are processed in the applicable accounting
systems and procedures appropriately.
Output controls, to ensure that output of the accounting systems and procedures are
correct and secured from any possible unauthorized access.
5.2. Tests of Controls
Test of controls are audit tests to measure the sufficiency and the effectiveness of control
procedures to mitigate the potential errors and fraud or the risk of misstatement in the
financial statements.
Tests of Control Involves:
a.
Observation, is observing the adherence to the applicable control policies and
procedures
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b.
c.
d.
e.
f.
Verbal inquiry, is collecting information or oral evidence from relevance and
independent parties, i.e. to determine the reasonableness of the recorded purchase
transaction.
Vouching, is trancing data backward from accounting records to source documents to
test the conformity between the recorded transaction with the existing of transaction.
Tracing, is tracing data forward from source documents to accounting records to test
the ability of the systems and control procedures to process transactions completely.
Sequence checking, is testing the existence and the completeness of serial number,
either in source docoments or in the records.
Direct examination, is direct testing to the implementation of the control systems and
procedures, such as the existing of authorization, supporting documents, checking
procedures, etc.
Students Task
Use your F4 size notebook:
1.5. Give example for each of the control procedures stated above
1.6. Give example of tests of controls for each of the control procedures that have been
mentioned in the task 1.5. above.
6.
SUBSTANTIVE TESTS
Substantive tests are audit tests to measure the fairness of the financial statements
presentation, or the fairness of the account balances presented in the financial statements. The
criterion of the fair presentations are the conformity of the reported account balances with the
supporting evidences (source documents and accounting records) and the applicable
accounting standards.
Substantive tests are conducted using the framework of management assertion, which are
consists of the following category of assertions:
a.
Existence of Occurence, the client asserts that assets and liabilities actually exist and
that sales and expense transactions actually occurred.
b.
Completeness, the client asserts that all transactions and accounts which should be
presented in the financial statements are included.
c.
Rights and Obligations, the client asserts that the company has rights to the assets and
that liabilities are obligations of the company at a given date.
d.
Valuation or Allocation, the client asserts that asset, liabilities, revenue, and expense
items have been included in the financial statements at appropriate amounts.
e.
Presentation and Disclosure, the client asserts that financial statement components are
properly classified, described, and disclosed.
Substantive Tests
Procedures of substantive tests involved:
a.
Analytical procedures, is conducted by comparing the audited figures with the
comparable figures, such as with previous figures, budgeted figures, or industry figures.
b.
Inspection or physical observation , is conducted by inpecting assets or documents
physically.
c.
Vouching, is conduted by checking the conformity between accounting records and
related source documents.
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d.
e.
f.
g.
h.
Tracing, is conducted by checking the completeness of recording the source documents,
by tracing from source documents to the related accounting records.
Counting, is conducted by counting the physical number of reported assets, such as
counting the inventory.
Confirmation, is conducted by written confirmation to a third party.
Verbal inquiry, is conducted by inquiring relevance staffs or parties.
Scanning, is conducted by scanning written information.
Students Task
Use your F4 size notebook:
1.7. Give short description the audit procedures to test the appropriatenes of each
category of management assertions for the audit of account receivable.
1.8. Give short description the audit procedures to test the appropriatenes of each
category of management assertions for the audit of bad debt expense as well as the
allowance for bad debt expense.
1.9. Give short description the audit procedures to test the appropriatenes of each
category of management assertions for the audit cash sales.
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