STANLEY DUBE
L0191881E
FORMAT
: BLOCK
LEVEL OF STUDY
: 2.1
DEPARTMENT
: ACCOUNTING AND FINANCE
MODULE
: AUDIT SKILLS AND PROCESS (COAF 2103)
LECTURER
: MR Y. NCUBE
INDIVIDUAL ASSIGNMENT 1
1. (a) Discuss how analytical procedures can be used as substantive audit procedures to
provide audit evidence. Illustrate your answer with an example.
(b) ISA 500 Audit evidence requires auditors to obtain sufficient appropriate audit evidence
to be able to draw reasonable conclusions on which to base their audit opinion. Discuss the
different sources of evidence available to auditors and assess their relative appropriateness.
DUE DATE 30/10/2023
1. (a) Discuss how analytical procedures can be used as substantive audit procedures to
provide audit evidence. Illustrate your answer with an example.
The International Standards on Auditing (ISAs) provide guidance on audit procedures,
including analytical procedures. Specifically, ISA 520 "Analytical Procedures" addresses the
use of analytical procedures in the audit process.
As per the Standard on Auditing (SA) 520 “Analytical Procedures”, the term “analytical procedures”
means evaluations of financial information through analysis of plausible relationships among both
financial and non-financial data. Analytical procedures also encompass such investigation as is
necessary of identified fluctuations or relationships that are inconsistent with other relevant
information or that differ from expected values by a significant amount. Thus, analytical procedures
include the consideration of comparisons of the entity’s financial information with as well as
consideration of relationships. ISA 520 establishes the responsibilities of the auditor regarding
the use of analytical procedures as substantive procedures and as a part of overall audit
strategy. The standard provides guidance on planning, performing, and evaluating analytical
procedures, including considerations such as the availability and reliability of data, the
development of expectations, the investigation of significant differences, and the
documentation of the procedures performed.
It is important for auditors to comply with ISA 520 and apply it appropriately when utilizing
analytical procedures as part of the audit process. However, it's worth noting that different
countries or jurisdictions may have their own auditing standards that are based on or aligned
with the International Standards on Auditing. Therefore, it is essential for auditors to consult
the relevant auditing standards applicable in their jurisdiction.
Audit analytical procedures are a set of techniques used by auditors to evaluate financial
information by analyzing relationships and trends in data. These procedures involve the
comparison of recorded amounts or ratios with expectations developed by the auditor, and
deviations from these expectations are investigated to identify potential misstatements or
risks.
Analytical procedures are an important tool used by auditors to obtain audit evidence and
evaluate the reasonableness of financial information. These procedures involve the analysis
of relationships and trends in financial and non-financial data to identify unusual or
unexpected fluctuations or patterns that may indicate potential misstatements or risks.
The International Standards on Auditing (ISAs) provide guidance on substantive audit
procedures. Specifically, ISA 330 "The Auditor's Responses to Assessed Risks" addresses the
auditor's responsibilities regarding substantive procedures in response to assessed risks of
material misstatement.
ISA 330 sets out the overall objectives of substantive procedures, which are to obtain
sufficient and appropriate audit evidence to reduce audit risk to an acceptably low level. The
standard provides guidance on the nature, timing, and extent of substantive procedures to be
performed based on the assessed risks of material misstatement at the assertion level.
The International Standards on Auditing (ISAs) provide guidance on audit evidence.
Specifically, ISA 500 "Audit Evidence" addresses the auditor's responsibilities regarding the
sufficiency and appropriateness of audit evidence obtained during an audit engagement.
ISA 500 sets out the overall objective of audit evidence, which is to provide a basis for the
auditor's opinion on the financial statements. The standard provides guidance on the
characteristics of audit evidence, the sources of audit evidence, and the evaluation of audit
evidence. Audit evidence refers to the information and supporting documentation that
auditors obtain and evaluate during an audit engagement. It is the basis for the auditor's
conclusions and opinions on the financial statements and provides reasonable assurance that
the financial statements are free from material misstatement.
Audit evidence is obtained through various audit procedures, including inspection,
observation, confirmation, recalculation, re - performance, analytical procedures, and others.
The auditor uses these procedures to gather evidence that supports the assertions made in the
financial statements. The evidence should be sufficient and appropriate, meaning it should be
of an adequate quantity and quality to support the auditor's conclusions.
When used as substantive audit procedures, analytical procedures involve comparing
recorded amounts or ratios with expectations developed by the auditor. The expectations can
be derived from various sources, such as prior period financial statements, budgets, industry
data, or the auditor's own knowledge and experience. Deviations from the expectations are
then investigated to determine whether they are indicative of errors, irregularities, or other
significant matters requiring further audit procedures.
To illustrate the concept, consider the following example:
Let's assume an auditor is performing an audit of a manufacturing company and wants to
assess the reasonableness of the company's cost of goods sold (COGS) for the current year.
The auditor's expectation is that the COGS should increase in proportion to the increase in
revenue, assuming a stable gross profit margin.
The auditor collects the financial statements for the current year and prior year, as well as
industry data on gross profit margins for similar companies. The auditor then calculates the
expected COGS for the current year based on the revenue and gross profit margin from the
prior year. The expectation is that the COGS should be within a certain range, considering
any known changes in the company's operations or industry conditions.
Upon performing the analytical procedures, the auditor finds that the COGS for the current
year is significantly higher than expected, given the increase in revenue. This deviation
prompts the auditor to investigate further.
The auditor may inquire about the reasons for the unexpected increase in COGS. They may
review production records, inventory records, supplier contracts, and other relevant
documentation to understand if there were any changes in the cost structure, production
methods, or procurement practices that could explain the deviation. The auditor may also
assess the reasonableness of the company's ending inventory balances and look for any
indications of potential inventory obsolescence or impairment.
Based on the results of the investigation, the auditor may conclude that the unexpected
increase in COGS is due to legitimate reasons, such as inflationary pressures or changes in
the business model. Alternatively, the auditor may identify material misstatements, such as
improper recording of costs or inventory valuation errors, which would require adjustments
to the financial statements.
In this example, the analytical procedures allowed the auditor to identify a significant
anomaly in the COGS and subsequently perform additional audit procedures to understand
the underlying causes. The analytical procedures served as a substantive audit procedure by
providing audit evidence to support the assessment of the reasonableness of the COGS and to
identify potential material misstatements.
It's important to note that while analytical procedures can be powerful tools, they have
inherent limitations. They rely on the availability of reliable and relevant data and the
auditor's professional judgment in developing expectations and assessing the significance of
deviations. Therefore, they should be used in conjunction with other substantive audit
procedures to obtain sufficient and appropriate audit evidence.
1. (b) ISA 500 Audit evidence requires auditors to obtain sufficient appropriate audit
evidence to be able to draw reasonable conclusions on which to base their audit
opinion. Discuss the different sources of evidence available to auditors and assess
their relative appropriateness
ISA 500, "Audit Evidence," outlines the requirements for auditors to obtain sufficient and
appropriate audit evidence to form the basis of their audit opinion. Auditors must gather
evidence from various sources to support their conclusions. Let's discuss the different sources
of evidence available to auditors and assess their relative appropriateness.
External Confirmations: Auditors may obtain direct confirmation from third parties, such as
banks, customers, suppliers, or legal professionals. External confirmations are considered
strong evidence because they provide independent verification of the information under audit.
Documentary Evidence: This includes documents such as invoices, contracts, bank
statements, and other written records. Documentary evidence is generally reliable and
verifiable, making it an appropriate source of evidence. However, auditors need to exercise
professional skepticism and consider the possibility of document forgery or manipulation.
Physical Inspection and Observation: Auditors may physically inspect assets, inventory, or
other tangible items. This source of evidence allows auditors to verify the existence,
condition, and valuation of these items. Physical inspection and observation can be highly
reliable but may not be feasible or practical for all types of assets.
Analytical Procedures: Auditors use analytical procedures to evaluate relationships and trends
among financial and non-financial data. This includes ratio analysis, trend analysis, and
benchmarking. Analytical procedures provide valuable evidence, especially when used in
conjunction with other sources. However, they may not be sufficient as the sole source of
evidence.
Inquiry and Confirmation: Auditors obtain information through inquiries of management and
other personnel within the organization. While inquiry provides valuable insights, it is
considered less reliable than other sources of evidence because it relies on the honesty and
competence of individuals being interviewed. Confirmation from management is generally
not considered sufficient on its own.
Reperformance and Recalculation: Auditors may reperform certain procedures or calculations
independently to verify the accuracy and completeness of financial information.
Reperformance and recalculation provide strong evidence but are time-consuming and may
not be feasible for all types of transactions.
Analytical Review: Auditors analyze financial statements and other relevant data to identify
unusual fluctuations, inconsistencies, or potential errors. Analytical review assists in
identifying areas that require further investigation. While it is a useful tool, it does not
provide direct evidence and must be supplemented with other sources.
The appropriateness of each source of evidence depends on various factors, including the
nature of the audit objective, the risk of material misstatement, and the availability of
alternative sources. Auditors must exercise professional judgment to determine the
sufficiency and appropriateness of the evidence gathered from each source. Combining
multiple sources of evidence enhances the reliability and persuasiveness of the audit
conclusion.
Assignment I
Question II
(a) The particular issues relating to controls in the audit of a small company like
Knits Co are as follows:
Limited resources: Small companies often have limited resources, including
personnel and technology. This can impact the design and implementation of
effective control systems.
Lack of segregation of duties: In small companies, it may be challenging to
achieve proper segregation of duties due to the limited number of employees.
This can increase the risk of errors or fraud going undetected.
Informal processes: Small companies may have less formalized procedures and
documentation compared to larger organizations. This can make it difficult to
establish and assess the effectiveness of controls.
Overreliance on key personnel: Small companies often heavily rely on key
personnel, such as the directors or a single employee, to handle critical
functions. This concentration of responsibility increases the risk of errors, fraud,
or disruptions due to key person dependency.
(b) Six control objectives of a sales system are as follows:
Accuracy: Ensuring that sales transactions are recorded accurately and
completely in the accounting system.
Authorization: Verifying that sales are properly authorized by appropriate
personnel, such as sales managers or directors.
Completeness: Ensuring that all sales transactions are captured and recorded in
the accounting system.
Timeliness: Ensuring that sales transactions are recorded in a timely manner to
provide up-to-date information for decision-making.
Segregation of duties: Separating responsibilities for sales order processing,
invoicing, and cash handling to prevent fraud or errors.
Documentation: Maintaining proper documentation for sales transactions, such
as order forms, invoices, and delivery notes, to support the completeness and
accuracy of recorded sales.
(c) Potential deficiencies in Knits Co's present system of accounting for sales
and receivables include:
Lack of control over order processing: The system does not have specific
controls to ensure the accuracy and completeness of sales orders, increasing the
risk of errors or omissions.
Absence of a sales day book and sales ledger control account: Without these
controls, it becomes challenging to reconcile and monitor the sales transactions
effectively, leading to potential errors and inaccuracies.
Inadequate credit control procedures: The company does not have a formal
procedure for monitoring and following up on overdue customer payments. This
increases the risk of bad debts and cash flow issues.
Limited segregation of duties: With only two accounts staff and a part-time
purchases and wages clerk, there is a lack of proper segregation of duties,
increasing the risk of errors or fraud going undetected.
Reliance on manual processes: The absence of automated controls and reliance
on manual filing and record-keeping increases the risk of errors, loss of
documents, and difficulty in retrieving information.
(d) Controls that Knits Co could feasibly adopt to overcome the identified
deficiencies include:
Implementing a sales day book and sales ledger control account: These controls
would help reconcile and monitor sales transactions, ensuring accuracy and
completeness.
Establishing a formal credit control procedure: This could include regular
monitoring of overdue payments, sending reminders to customers, and
implementing a structured process for debt collection.
Introducing segregation of duties: Assigning different individuals to handle
sales order processing, invoicing, and cash handling to reduce the risk of errors
or fraud.
Investing in technology: Implementing an accounting system with integrated
controls, such as automated order processing, inventory management, and sales
reporting, to improve efficiency and accuracy.
Enhancing documentation practices: Implementing a document management
system to properly store and retrieve sales-related documents, ensuring
completeness and ease of access for audit purposes.
(e) The five components of internal control in ensuring effectiveness and
efficiency are as follows:
Control environment: This component sets the tone for the organization's
internal control system, including the commitment to ethics, integrity, and
competence, as well as the establishment of appropriate organizational structure
and lines of authority.
Risk assessment: This involves identifying and analyzing risks that could
impact the achievement of objectives, and implementing measures to mitigate
those risks.
Control activities: These are the policies and procedures designed to ensure that
management's objectives are achieved, including authorization, segregation of
duties, physical controls, and IT controls.
Information and communication: This component involves the effective
communication of information, both internally and externally, to support the
functioning of the internal control system. It includes clear and timely reporting
of financial and non-financial information.
Monitoring: This component involves ongoing monitoring of the internal
control system to assess its effectiveness and make necessary improvements. It
includes both internal and external audits, as well as management reviews and
self-assessments.
(f) The audit procedures to be performed in testing internal control include:
Inquiry and observation: Interviewing key personnel involved in the control
processes and observing control activities to understand how they are
performed.
Inspection of documentation: Reviewing relevant documents, such as order
forms, invoices, delivery notes, and control logs, to assess the adequacy and
effectiveness of control procedures.
3.Testing of controls: Performing tests to determine whether the control
procedures are operating effectively, such as selecting a sample of sales
transactions and tracing them through the system to ensure proper authorization,
accuracy, and completeness.
Reperformance: Independently performing control procedures to verify their
effectiveness and accuracy.
Walkthroughs: Following the flow of transactions through the system, from
initiation to recording, to identify potential control weaknesses or breakdowns.
IT system testing: Assessing the effectiveness of IT controls, such as access
controls, data integrity checks, and system-generated reports, through testing
and analysis.
Analytical procedures: Performing analytical procedures to identify any unusual
or unexpected trends or fluctuations in sales and receivables, which may
indicate control deficiencies or potential risks.
Reconciliation and review: Reconciling sales records with supporting
documentation, such as dispatch notes and invoices, and reviewing the
completeness and accuracy of recorded sales.
Evaluation of management review processes: Assessing the effectiveness of
management's review of control activities, including the review of exception
reports, management reports, and internal audit findings.
Testing of compliance with policies and procedures: Verifying whether
employees are following established policies and procedures related to sales and
receivables, such as credit approval procedures, pricing policies, and discount
authorizations.
CITATION:
1. Marx, B. & Van Der Watt, A., 2004 “Dynamic Auditing” Seventh Edition; LexisNexis,
Butterworths, Durban
2. Hayes, R. & Dassen, R., 2005 Principles of Auditing, Second Edition; Prentice Hall.
3. Porter, B., Simon, J. & Hatherly, D. 2003 Principles of External Auditing, Second Edition;
John Wiley& sons Ltd.
4. Millicamp, A.H. & Taylor, J.R., 2008 Auditing, Ninth Edition; Cengage Learning EMEA.