LAGOS CITY POLYTECHNIC, IKEJA

NATIONAL DIPLOMA IN ACCOUNTANCY

YEAR II

AUDITING I

CODE: ACC 213

NATIONAL DIPLOMA IN ACCOUNTANCY

Course: AUDITING 1

CODE : ACC 213

CREDIT HOURS: 45 HOURS

GOAL: To expose students to the concepts, theories, principles and techniques of Auditing.

GENERAL OBJECTIVES

On completion of this module, students should be able to:

1.0 Understand theory and philosophy of auditing.

2.0 Know rights, duties and responsibilities of the auditor.

3.0 Understand professional ethics.

4.0 know the Auditor’s Liabilities.

5.0 Understand the appointment and removal of Auditors.

6.0 Know the inter-relationships of the audit functions and the internal control

system..

7.0 Know selections of areas of work control, in-depth tests and use of graphing and

of sampling techniques.
DETAILED COURSE OUTLINE
1.0 GENERAL OBJECTIVE : Understand theory and philosophy of auditing.
Week 1

1.1 Define Auditing

1.2 Relate the history of auditing and philosophy of auditing

1.3 Explain the theory and philosophy of auditing.

1.4 Explain the concepts and conventions underlying the practice of auditing

1.5 Explain the generally accepted auditing standards (GAAPs)

1.6 Distinguish between auditing and accounting

2.0 GENERAL OBJECTIVE : Know the rights, duties and responsibilities of auditor.

2.1 Explain the role of auditors in an enterprise

2.2 Explain the rights, duties and responsibilities of auditors to a sole trader, a partnership and to

a public organization

2.3 explain the auditors’ right to remuneration

2.4 Explain the significance of the following as they affect an audit:

- source of auditors’ power, audit plans, programmes, engagement letters, standard of field -
work and audit process

2.5 Explain what audit working papers mean and the objectives of audit working papers.

2.6 Distinguish between a permanent audit file and a current audit file and state the documents

found in each of them.

2.7 Explain auditing approaches and significance of systems approach in modern auditing,

2.8 Explain what an audit trail means and its indispensability to vouching approach in auditing

2.9 Explain the methods or approaches to audit such as final audit, interim audit, procedural

audit, continuous audit and balance sheet audit.

2.10 Explain the advantages and disadvantages of each in 2.9 above.

3.0 GENERAL OBJECTIVE: Understand Professional Ethics

3.1 Define professional ethics

3.2 Describe the concept of independence.

3.3 Relate such ethics to association with directors, shareholders and clients

3.4 Explain an auditor’s responsibilities to the profession, colleagues and society.

4.0 GENERAL OBJECTIVE; KNOW THE AUDITORS’S LIABILITIES

4.1 Define liability

4.2 State the source of liability

4.3 Explain liability for negligence under common law

4.4 Explain liability under statute- Civil and Criminal Law

4.5 Discuss recent developments in third party liability

5.0 GENERAL OBJECTIVE; Und stand the Appointment and Removal of Auditors

5.1 Explain the procedure for the appointment and removal of auditors –legal and other requirements

5.2 State the procedure for fixing the remuneration of auditors

5.3 State the qualification of an Auditor as distinct from that of Accountants

6.0 GENERAL OBJECTIVE; Know the inter-relationship of the audit functions and the internal control
system

6.1 Define internal Control, Internal Audit and Internal Check

6.2 Explain the significance of an audit assignment

6.3 Explain the characteristics of internal audit functions and internal control questionnaires

6.4 Explain the significance of internal audit functions and internal control questionnaires an audit
6.5 Explain the significance of strong internal control systems

7.0 GENERAL OBJECTIVE; Know selection of areas of work control, in-depth tests, use of graphs, and
sampling techniques

7.1 Define work control, in-depth graphing and sampling techniques

7.2 state the significance of organizational charts and flow charts in an audit procedure for work control,
in-depth graphing and sampling techniques.

7.3 Explain the testing of the system of internal control, compliance tests, transaction tests and

functional test.
 LAGOS CITY POLYTECHNIC, IKEJA

NATIONAL DIPLOMA IN ACCOUNTANCY

Course: AUDITING 1
CODE: ACC 213 UNITS 3

CHAPTER ONE
THEORY AND PHYLOSOPHY OF AUDITING

At the end of the lesson, students are expected to understand the theory and philosophy of
auditing. Specifically, they should be able to:

1.1 Define Auditing

1.2 Relate the history of auditing and philosophy of auditing

1.3 Explain the theory and philosophy of auditing.

1.4 Explain the concepts and conventions underlying the practice of auditing

1.5 Explain the generally accepted auditing standards (GAAPs)

1.6 Distinguish between auditing and accounting

1.0 Definition of Auditing

Auditing is a process employed to enable the auditor to express an opinion whether the financial
statements are prepared, in all material respects, in accordance with an identified financial
reporting framework or other criteria. It can be simply illustrated as follows:
Compliance of
Auditing – a financial statements
process with:
Audit
which
opinion to
enables All identified
be made on
financial reporting
framework; or

Other criteria.
Figure 1: Auditing as a Process Facilitating Opinion Making

Using the American Accounting Association’s definitions of an audit, auditing may as well be
defined as ‘a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of correspondence between
these assertions and established criteria and communicating the result to interested users.’

According to the Nigerian Standard on Auditing (NSA) 1, auditing of financial statements is an

assurance engagement as stated in the International Framework for Assurance Engagements.
Elements and objectives of an assurance engagement were defined and prescribed in the
Framework. The objective is to enable the auditor to express an opinion on whether the financial
statements are prepared, in all material respects, according to an applicable financial reporting
framework.

Regarding assurance engagement, this is taken as an engagement in which a practitioner

expresses a conclusion designed to enhance the degree of confidence of the intended users other
than the responsible party about the outcome of the evaluation or measurement of a subject
matter against criteria.
 Engagement
where a Intended users Focus is not the
practitioner about the responsible
expresses a outcome of the party (preparer
conclusion evaluation or of the financial
(opinion) to measurement of statements).
enhance a subject matter
confidence against criteria
of …….

Figure 2: Auditing as an Engagement to enhance confidence of intended Users

From figure 2 above, it is evident that three parties are involved in auditing. The parties are:

(i) The responsible party – who prepared the financial statements in accordance with
relevant financial reporting framework;
(ii) The practitioner – often a qualified chartered accountant who expresses an opinion on
the extent to which the financial statements comply with relevant financial reporting
standards; and
(iii) The intended users – who use the attested financial statements to make informed
economic decisions.
The parties are well illustrated in a triage of auditing as follows:

The responsible party

The practitioner The intended users

Figure 3: The Triage of Auditing

From the above, auditing may be defined as an examination on test basis and the communication
of the result of the test of attestation to members of the company as well as to members of the
audit committee in case of a company that is quoted on the stock exchange.

The objective is to lend credence to the financial statements so that third parties may rely on it in
taking economic decisions. This explains in part, why most users of financial statements require
such statements to be reviewed by independent auditors who would then give informed opinion
on the extent to which the financial statements comply with all necessary financial reporting
frameworks.
In Nigeria, financial reporting frameworks include:

(i) Companies and Allied Matters Act (CAMA) 1990 – a new CAMA 2018 now exists
and will soon override the 1990 Act;
(ii) Relevant Accounting Standards – local and international;
(iii) Regulatory Standards or laws as established by specific regulators as tabulated below:
Regulator Standard/Law Entity being controlled

SEC ISA 2007 Quoted companies

CBN BOFIA 2002 Banking institutions

NAICOM NIA Insurance companies

PENCOM Pensions Act Pension administrators

1.2 History and Philosophy of Auditing

According to Archeological findings, records relating to auditing activity dates back to early
Babylonians times i.e. about 3,000 B.C. The practice was for landowners to request for “hearing”
of accounts of activities of farmers to whom lands were rented out for commercial purposes.
Historically, hence, auditing evolved from the “hearing” by overseers through who land tenants
rendered accounts to landlords.

With the advent of Industrial Revolution, the practice of modern auditing began to take form as
modern corporations evolved with the process of allocating resources, especially financial,
through financial intermediaries and institutions. The process was further aided by agency theory
which segregates ownership of an entity from its management.

It follows, therefore, that for an efficient allocation of resources, credible reports must be
rendered by those managing an organization on behalf of the owners.

Such reports, usually in the form of financial statements and associated notes, could hardly be
comprehended by corporate owners, investors and many other interested parties.

Auditing in this regard, bridges the gap. It provides an independent and expert opinion on the
fairness of the financial reports prepared and presented by management of an entity. The
philosophy of auditing, hence, is to strengthen the agency theory of opiniating, on management
reports which may not be entirely perfect, within a defined framework of criteria.
 1.3 Theory and Philosophy of Auditing
According to Martz and Sharaf, auditing is a field of knowledge built on a central core of
abstract thoughts including mathematics, logic and metaphysics. This led them to build a
hierarchical scheme of a auditing consisting of:

1. Philosophical foundation;
2. Postulates
3. Concepts
4. Precepts and
5. Practical Applications.

2
3
4

Figure 1.4 Hierarchical scheme of auditing

A statement agreed upon to be true (also called axiom)

Postulates are agreed upon statements to be true. They are also called axioms.popular
postulates in auditing include the following:
1. Audit enhances confidence in financial statements. It does not relief management and
those charged with governance of their responsibilities which are fundamental to conduct
of audits.
2. Audit provides reasonable level of assurance, not absolute level of assurance.
3. Audit opinions are persuasive rather than conclusive.
4. Audits not responsible for the defection of misstatement that is not material to the
financial statements a whole.

Precept
A precept is a rule or principle describing a particular course of action. It also relates to
law which is an authorized direction or order. (www.thefreedictionary.com)
Concept

A concept is an abstract or general idea inferred or derived from specific instances. It is a thought
or idea, perception or notion. It mainly consists of precepts. This may explain why an adage says
that precepts precede an adage.

Conventions

Conventions are a set of agreed upon, generally accepted standards, often taking the form of
custom. When a concept is generally accepted, it becomes a convention.

Practical application

This relates to utilizations of either of theory, postulate, concept, principle in the performance of
accounting duties. Financial statements, for example, are prepared in accordance with applicable
financial reporting framework which consists of legal, ethical, regulatory and professional
accounting standards.

According to NSA 1, Applicable Financial Reporting Framework relates to

‘The financial Reporting framework adopted by management and where appropriate, those
charged with
governance in the preparation of the financial statements that is acceptable in view of the nature
of the entity and the objective of the financial statements or that is required by law or regulation.’

1.4 Concepts and conventions underlying the practice of auditing

Concepts are ideas derived from specific instances while conventions are a set of agreed upon
generally accepted ideas.

Mautz and Sharaf (1961) suggested five concepts

1. Evidence
2. Due Audit Care
3. Fair Presentation
4. Independence
5. Ethical conduct.

More popular concepts underlying the practice of auding are:

1. Evidence – reduces audit risks

2. Subject matter- Accountability
3. Suitable criteria
4. Parties involved
5. Report.
Conventions in this regard are:

Interrelationship between concepts and convention is illustrated below:

Concepts

Accepted Generally Accepted

Conversions

Standards

Figure 1.5 Relationships between concept and convention

According to NSA1, the essence of an audit is to enhance the degree of confidence of intended
users. To achieve such objective, an opinion is expressed in the auditor’s report to state if the
financial statements had been prepared in line with AFRF-ISA/NSA

Generally Accepted Auditing Standards are the principles designed to support the auditors in
obtaining reasonable assurance. These standards are set by the International Audit and Assurance
Standard Board (IAASB) globally and locally by the Nigerian Auditing Standards Committee
(NASC)

While IAASB is an arm of the International Federation of Accountants (IFAC), NASC is an arm
of the Institutes of Chartered Accountants of Nigeria. These standards are aimed at providing
“services of consistently high quality in the public interest”. They are essential principles and
essential procedures to be followed in the conduct of an audit of financial statement.

1.5 Generally Accepted Auditing Procedures /Standards (GAAPs)

Key principles, according to NSA 1 which substantially complies with ISA 200 are:

i. Exercise of professional judgment and maintenance of professional skepticism

throughout the planning to performance of the audit.
ii. Identification and assessment of risks of material misstatement, either due to fraud or
error.
iii. Understanding of the entity and its environment, including its internal control in order to
achieve (iii) above
iv. Obtaining sufficient appropriate audit evidence about the existence of material
misstatements
v. Designing and implementing of appropriate responses to the assessed risks in order to
sustain standard (iv)
 vi. Forming an opinion on the financial statements based on conclusion drawn from the audit
evidence gathered from field work.
1.6 Distinction between Auditing and Accounting

In a most simplistic form the main difference between auditing and accounting is that while
accounting focuses on preparation and presentation of financial statement, auditing is more
concerned about forming an opinion on the compliance of the financial statement with the
applicable financial reporting framework. Other distinctions are as tabulated below.

Distinction between Auditing and Accounting

Auditing Accounting

1.Meaning Examination of books of Accounts Recording, maintenance of books accounts.

Nature of Job Not so mechanical with application Mechanical need to follow established rules
of professional judgment SAS, CAMA, IRFS etc.
Responsibility Determined by law e.g. (AMA Management determined responsibility
(1990)
Time Usually less than one year-mostly Usually one year
two weeks for field work
Purpose To give assurance on true and fair To show operating performance in operating
view thus improving confidence in statements of financial position etc.
financial statement
Rewards Fees approved at annual general Salaries and wages approved by
meeting management and those charged with
governance.
Liability May arise after presentation of No liability may arise.
report, rooted in law.

QUIZZES

1. Auditing is a process employed to enable the auditor to express an ……….. whether the
financial ……..are prepared, in all material respects, in accordance with an identified
financial reporting ………… or other criteria
2. One theory upon which auditing rests is……………
3. Mautz and Sharaf (1961) developed a …………..scheme for auditing.
 4. One postulate in auditing is ……………while ……………is a concept.
5. When concepts are generally accepted, they become…………

REVISION QUESTIONS

Narrative Questions

1. Briefly define auditing.

2. Establish the relationship between the history of auditing and the agency theory.
3. What is the essence of the philosophy of auditing in audit practice?
4. Show the interrelationship between philosophy of auditing and practical applications in
auditing.
5. Explain the following relative to auditing:
(i) Postulates; (ii) Concepts; (iii) Precepts; (iv)Philosophical foundation; and
(v) Practical application.
6. State three concepts and conventions underlying the practice of auditing.
7. What are ‘generally accepted auditing principles’ in auditing?
8. How would you differentiate between auditing and accounting?

ASSIGNMENTS

1. (a) What is auditing?

(b) Briefly explain the contribution of Mautz and Sharaf to the development of auditing theory.

2. (a) what is an audit

(b) Briefly explain the objective of auditing of financial statements.
(c) State two postulates in auditing.

3. (a) With reference to the Nigerian Standards on Auditing number, explain four key principles
underlying the performance of statutory audit functions.
(b) ) Indicate what the following Nigerian Standards on Auditing (NSAs) stand for:
(i) NSA 2; and
(ii) NSA 9.

4. (a) State two auditing postulates.

(b) With the aid of an appropriate chart, describe the relationship between auditing concepts
and auditing standards.
(c) Indicate what the following Nigerian Standards on Auditing (NSAs) stand for:
(i) NSA 2; and
(ii) NSA 9.
5. Visit the office of an external auditor in your locality. Seek for distinctions between auditing
concepts and auditing conventions. Write a brief report on the response.
 CHAPTER TWO

THE RIGHTS, DUTIES AND RESPONSIBILITIES OF AUDITORS

At the end of this lecture, students must be able to:

2.1 Explain the role of auditors in an enterprise

2.2 Explain the rights, duties and responsibilities of auditors to a sole trader, a partnership and to

a public organization

2.3 explain the auditors’ right to remuneration

2.4 Explain the significance of the following as they affect an audit:

- Source of auditors’ power, audit plans, programme engagement letters, standard of field

work and audit process

2.5 Explain what audit working papers mean and the objectives of audit working papers.

2.6 Distinguish between a permanent audit file and a current audit file and state the documents

found in each of them.

2.7 Explain auditing approaches and significance of systems approach in modern auditing,

2.8 Explain what an audit trail means and its indispensability to vouching approach in auditing

2.9 Explain the methods or approaches to audit such as final audit, interim audit, procedural

audit, continuous audit and balance sheet audit.

2.10 Explain the advantages and disadvantages of each in 2.9 above.

2.1 The role of the Auditor in an Enterprise.

Often, the statement of financial position is viewed as a coloured transparency, “or an optical
delusion” rather than a snapshot of the financial position of an entity. This is because unlike
historians who record historic events independently, those making financial reports are part of
the various events leading to the records. Moreover, reports are presented as prepared by
employees under the directive of management thus creating a situation where the litigant is also
the JUDGE!

The implication of the above is that financial statement could be misstated by ignorance,
personal bias, and self- interest, careless or even outright dishonesty.

These shortcomings could be addressed by an independent auditor who attests to the reliability of
the financial statement, thus acting as lubricants to the financial machinery in free economies of
the world. This also keeps the economic system operating at the highest level of efficiency thus
promoting capital market efficiency globally. The implication of this for an enterprise is that
mistrust and distrust is minimized among stakeholders thus enhancing maximum support from
creditors, investors, government and shareholders. In an enterprise therefore, auditing provides
credibility to both financial statements and non-financial statements. At this point, it is important
to note that financial statements under the International Financial Reporting Standards (IFRS)
include;

(i) Income statement or Statement of Comprehensive Income;

(ii) Statement of Financial Position;
(iii) Cash Flow Statement; and
(iv) Statement of Changes in Equity.

1.2The Rights, Duties and Responsibilities of Auditors

The client of an auditor may be a sole trader, a partnership or a public organization
(incorporated company). The rights, duties and responsibilities of an auditor though
substantially alike may differ in some respects. Some of the distinctions may relate to the
instrument creating the entity being audited. While the sole proprietor and the partnership
may be unincorporated and regulated by letters of engagement and deeds of agreement
respectively, public organizations or public limited liability companies are regulated by
the Companies and Allied Matters Act (CAMA) 1990 and the articles and memorandum
of association. Ethical postulations by professional accountancy bodies also define the
rights, duties and responsibilities of auditors.
Some of these are tabulated below:
 Rights, duties and responsibilities of an auditor to a sole trader, a partnership and to a
public organization
Sole trader Partnership Public organization
(Limited Company)
Rights as detailed in letter as defined in letters as defined in letter of
Of engagement agreement and other engagement and the
Documents Article of Association
Duties as per letter of
Engagement and same same
Professional ethics

Responsibilities as per letter of

Engagement and same same

Professional ethics

The rights of an auditor include the right to:

(i) Access to book maintained by the entity on financial and other related matters (s.360
of CAMA, 1990)
(ii) Obtain information from officials of the company
(iii) Be heard on auditing matters – especially presentation of his report at a general
meeting
(iv) Be heard at a meeting where he is to be removed (s.364 of CAMA, 1990)
(v) Receive his remuneration.
The duties of an auditor to his clients include:

(i) Performance of his duties with due diligence and care.

(ii) Expression of an opinion on the financial statements presented by sole a trader,
partners and directors of a public organization. In the case of a public organization,
such opinion is to be read at a general meeting of owners of the entity.
The responsibilities of the auditor include:

(i) Performing his duties as provided in his letter of engagement and according to the
scope agreed with the client- sole trader, partners or the company as may be
represented by the directors.
(ii) Application of all relevant auditing standards and procedures in the execution of his
duties.
(iii) Observation of all ethical standards.

2.3 The Auditor’s Right to Remuneration.

The auditors performs work, hence, must be paid for his efforts. Duties performed include:

i. 1nspection of books of accounts and other records of the company.

ii. Obtaining information and other evidence from the directors and other personnel to form
a professional opinion.
iii. Attending meetings, especially the annual general meetings of shareholder to make or
explain issues relating to the financial statement.
iv. Communicating with those charged with governance the board and the audit committee.
v. Exercising reasonable skill and care in the discharge of his duties failing which civil or
criminal liabilities may arise.

2.4 The significance of some issues relating to the auditor’s source of Power

The source of the auditors’ power affect their independence and hence, the quality of the output
in relation to objectivity and integrity. The source of the auditors’ power is usually the
Companies and Allied Matters Act 1900 in Nigeria. This is significant in that it sets out
guidelines for the appointment removal and liabilities of erring auditors. The source also defines
the duties of the auditors as well as their rights. The various provisions ensure that auditors are
not unduly controlled by a director of a group of them thus strengthening independence of the
auditor and the integrity of his report. In most cases power of corporate directors over auditors
are moderated by the Audit Committee through members of the company appoint auditors at
annual general meetings.

The source should be such that will promote professionalism rather than self interest.

Audit Plans and Programmes

Audit plans is a stage in the audit process undertaken after evaluating the system of internal
control to assess its strengths and weaknesses. It details the nature and extent of audit tests. Audit
tests assist in executing audit assignments relative to verified accounting transactions and the
perceived level of audit risk.

The plans also help to relate audit programs to the individual corporate accounting system as
well as the nature of control. The usefulness of audit plans depends on the care upon which the
various systems had been evaluated. Where the system is found to be strong, transaction tests
could be carried out. On the other hand, where a significant control abnormally is observed,
weakness tests may be more useful. It is concerned more about how to conduct the audit
efficiently.

Audit plan, Internal Control and Audit Programmes

 Internal
Audit
Control Strong? No
Plans

Yes

Transaction
Audit Programmes
Test

Weakness Test

(Substantive Test)

Engagement Letters

These are written agreements to perform services in exchange for compensation. They are
traditionally used in field of finance, accounting, law and consulting to define the specifics of the
business relationship. In most cases, engagement letters are sent by the service firm to an officer
of the engaging firm. Endorsement of such letters server as contract.

In relation to auditing, NSA1 which substantially complies with ISA 200 defines Engagement
letter as “Written terms of an engagement in the form of a letter” NSA2 “Agreeing the terms of
audit engagements” which complies with ISA210 deals with the responsibility of the auditor in
agreeing the terms of the engagement with:

i. Management, or
ii. Those charged with governance where appropriate.
The standard is to establish that certain/conditions for an audit exist. Facilitation of such
preconditions rest with the management and where appropriate, those charged with governance.

Standard of fieldwork

-NSA 3 / ISA 220

The standard of fieldwork should be very high and aimed at reducing audit risk to a level of
insignificant. Audit risk implies the auditor accepting some level of uncertainty while
performing the audit function. Such uncertainty may relate to

i. The competence of evidence.

ii. The effectiveness of the client’s internal control structure
 iii. whether the financial statements are fairly stated.
The Audit risk model could be presented as:

PDR = AAR where PDR = Planned Detection Risk

IR x CR AAR=Acceptable Audit Risk

IR= Inherent Risk

CR=Control Risk

The Audit Process

The Audit Process, according to Phillip Wallage, could be likened to the empirical scientific
cycle as follows

3-Phase Standard Audit Process

Stage 1

Begin:

Client’s
request

Followed by:

Stage 2 A plan of the Audit

&

Tests of evidence

Stage 3 Leading to:

A judgment or

Audit opinion

4-Phase Standard Audit Process

stage 1
Client acceptance

-Preplanning

Stage 2
Planning

Stage 3 Testing and Evidence

Evaluation

Stage 4 and

Judgment

2.5 Audit working papers – meaning and objectives

What Audit Papers Mean

Audit papers mean documents which record all audit evidence gathered during the field work of
an audit engagement. They are gathered and used to support the audit work done in order to
provide assurance that the audit assignment was conducted in accordance with relevant audit
standards.

Other objectives of audit papers (AP) include:

i) showing that the audit was carried out properly and adequately planned;
ii) proving that adequate audit staff were engaged with appropriate and adequate
supervision;
iii) evidencing that appropriate reviews were undertaken ; and
iv) proving that the evidence gathered were sufficient and appropriate to support the
audit opinion.
Working papers are the exclusive properties of the auditor and ethically, cannot be discussed
with third parties unless the client consents or under the limited specified cases cited in the
International Standards on Auditing (ISA) 230 on documentation or as required by law as in case
of court order or public interest.

Forms of APs could be flowchart, manual, narrative note, checklist or questionnaire.

(Wikipedia, 16 March 2013)

2.6 Distinction between a permanent audit file and a current audit including
documents found in each of them
Audit files contain a list of event identifiers, each of which can be verified. (ibn.com). example
include stock-taking file which contains a list of stock items which could be physically verified.
They are forms of audit working papers and could be classified into permanent audit files (PAF)
and current audit files (CAF).

Permanent Audit Files (PAF)

These usually contain documents and matters of continuing importance often required for more
than one audit assignment. They are usually indexed. Dominant contents include:

(a) statutory matters relating toe the audit and the financial statements e.g. copy of the
Companies and Allied matters Act (CAMA) 1990;
(b) The Rules and Regulations of the entity, especially memorandum and articles of
Association in case of public companies, deeds of partnership in case of partnership or
 Certificate of Incorporation by the Corporate Affairs Commission (CAC) in case of
unincorporated entities (sole traders and enterprises).
(c) Organization of the entity
(Millichamp p81-86)

Current Audit File (CAF)

These relate to matters on the current engagement in the current year, it contains:
(a) Copy of the financial statements being audited as duly signed by the directors;
(b) An index to the file;
(c) Description of the Internal Control System in te form of an Internal Control
Questionnaire (ICQ), flowcharts, or written description as well as specimen
documents;
(d) Audit programmes detailing work to be carried out, tests to be conducted, results and
cross references to the internal control records and letter of weakness.

2.7 Auditing Approaches and significance of systems approach in modern auditing.

Five auditing approaches could be identified from the literature. These are:

(i) Substantive Procedure Approach (SAP).

(ii) Balance Sheet (Statement of Financial Position) Approach (BAS).
(iii) Systems – Based Approach (SBA).
(iv) Risk – Based Approach.
(v) Process – Based Approach.
The Substantive Procedures Approach

This is also known as the vouching approach or the direct verification approach. This method is
focused on testing large volume of transactions and account balances without focusing on
specific areas of the financial statements.

The Balance Sheet Approach

This revolves round substantive approach but with focus on the balance sheet (statement of
financial position) accounts. Very few procedures are carried out on income statement (profit and
loss) items.

The Systems-Based Approach

This requires the auditor to assess the effectiveness of the internal controls of the entity.
Subsequently, substantive procedures are directed at those areas considered inefficient at meeting
the objectives of the system. Where it is considered that system objectives will be met, reduced
testing is carried out.

The Risk-Based Approach

Under this approach, focus is on areas of the financial statements which may contain
misstatements – error or omissions – consequent upon risks faced by the entity.

The significance of System-Based Approach

The significance of this approach is that it reveals changes between successive balance sheet
dates. It is an approach in which the auditor seeks reassurance as to the validity of financial data
produced by the accounting system instead of the audit of the balance sheet itself.

2.8 Audit trail means and its indispensability to vouching approach in auditing
The Audit Trail
An audit trail is the sequence of paper work that authenticates accounting entries. It is used to
track accounting activities and helps in reconciliation of accounting transactions and entries.

Audit trail

Accounting Entries

Correc Invalidate
No
t?

Yes

Validate

Indispensability of Vouching Approach in Auditing

Vouching relates to the inspection of documentary evidence which supports or substantiates a
transaction. It is an essential part of auditing. It helps to establish the authenticity of the
transactions recorded in the primary books of accounts. This is achieved by establishing and
following the audit trail.

This approach is evident in every audit assignment and no approach to auditing is complete
without vouching. Where the internal control is deemed effective, extent of vouching may not be
as extensive as in cases where internal control system is deemed weak. It follows hence that
vouching is indispensable in auditing because every approach to auditing employs it.
2.9 Other Methods or Approaches to Auditing

Other methods or approaches to auditing include:

(i) Final audit;

(ii) Interim audit
(iii) Procedural audit
(iv) Continuous audit
(v) Balance sheet audit.
Final Audit

This approach is focused on auditing after the close of the financial period such that the audit
report could be presented to the Board of Directors and at the annual general meeting.
Furthermore, this audit form the basis of ssubmission to regulators, and statutory authorities. It
could also be referred to as ‘complete audit.’ Some authors also refer to it as ‘Balance Sheet
Audit.’

Interim Audit

This is the type of audit used at a period in time during the current year. It makes it possible to
complete at least some of the tasks involved with the final audit. It also assist in the provision of
shareholders and other interested p[arties with final audit data eaqrlier than if final audit was
conducted after the end of the financial year. Usually it happens between two annual accounts
and it could be used for paying interim dividends.

Procedural Audit

This is concerned with adherence to procedures. It equally reveals the practicability of

established procedures. A procedure in this case is defined as a determined way of performing an
activity or executing a process. It investigates how things are done.(DIN EN ISO 910000)

Continuous Audit

Often called running audit, this is an exercise that runs throughout the financial year – with
regular or irregular intervals. It allows financial information to be checked or shared with ease..
It is the most detailed audit.

Balance Sheet Audit

This focuses on the balance sheet items with limited review of the items in the balance sheet.

QUIZZES
 1. One difference between historical records and financial records is that historical records
are made by individual ……………. whereas financial records are made by
…………….in the process or event.
2. A paradox in financial reporting is that the litigant may also be the ……………..
3. Auditing procedures ensure that misstatements arising from …………….or …………,
among others, are minimized in financial statements.
4. The client of an auditor may be a sole trader, …………… or a public ………..
5. Ethical postulations by professional accountancy bodies usually define the ………, duties
and …………………. of auditors

REVISION QUESTIONS

1 (a). What is an audit trail?

(b) Explain how audit trails help in:

(i) Bank reconciliation (ii) Stock reconciliation (iii) Verification of trade debtors

(c ) You have just been appointed as the lead auditor to investigate an allegation of cash fraud at
Pinch me Plc. Briefly describe how you will establish the audit trail for cash collection and posting into
the general ledger.

2 Discuss the relevance of vouching in audit trail.

3. Distinquish between Final Audit and Interim Audit.

4. Briefly explain how the source of the power of JK Associates (Chartered Accountants) may
affect their duties as the auditors to Jukum Bank Plc, Ikeja.

5. (a) List two roles of the auditor in an enterprise.

(b) State two procedures which an auditor must perform throughout his engagement.

6. State two concepts in the philosophy of auditing as suggested by Mautz and Sharaf.

7. Give four reasons why the external auditor of a company has the right to his remuneration.

8, Recently, a top official of Yankuri Ltd, a company where you work as an auditor wonders what
external auditors mean by ‘audit working papers.’ You are required to:

(i) Explain what audit working papers are;

(ii) State the contents of audit working papers; and
(iii) Justify the use of working papers in auditing.

9. (a) What is the significance of System Based Approach (SBA) to auditing?

 (b) Justify the superiority of risk-based audit to SBA

10. (a) Explain the main focus of the Risk-based Approach to auditing.
(b) State two major roles of inherent risks in auditing.

ASSIGNMENTS

1. Visit the office of a practicing auditor in your locality. Solicit for audited financial statements of a
client of the firm for three years. Note charges as auditor’s remuneration for the years. Find out
from the auditor why he is being remunerated for each year.
Write a brief report on your experience.

2. Choose a corporate entity of your choice, having an internal audit department. From the
internal audit department, solicit for, and list contents of their working files. State changes (if
any) within the working files within two financial years.
3. Discuss the relevance of the following in statutory audit:
(a) Companies and Allied Matters Act (CAMA) 1990.
(b) Investment and Securities Act (ISA) 2007.
(c) Insurance Act.
(d) The letter of engagement.
 3. 0 CHAPTER THREE

PROFESSIONAL ETHICS

At the end of this lesson, students must Understand Professional Ethics. They must also be able to:

3.1 Define professional ethics

3.2 Describe the concept of independence.

3.3 Relate such ethics to association with directors, shareholders and clients

3.4 Explain an auditor’s responsibilities to the profession, colleagues and society.

3.0 Professional ethics

In working life, there is always a war between the need for service and the desire for gain –even
where unmerited. The antidote to that war is a guide to help in making sound decision when
faced with moral issues in work environments.

Ethics Moral values

Facing
Codes Guiding Professionals
Professionals

Service Crave for

Wealth

Figure 3: Ethics as guide to moral values

3.1 Definition of professional ethics.

Professional ethics is that set of rules or guides which help the professionals, including
professional accountants, in making sound judgments. They guide the use of specialized
knowledge or use of judgment when faced with issues of morality in the discharge of
professional duties. Also, they are codes of conduct which must be followed when executing
professional work. Essentially, ethics deal with moral values including an insight in the concept
of ‘good’ and ‘bad.’
From the work of Allyssa Mcgranahan (2020) it could be inferred that ethical issues relate to
problems, situations, or opportunities requiring an individual, group, or organization to choose
among several actions which must be evaluated as right or wrong, ethical or unethical.

3.2 The Concept of Independence.

Independence means freedom from control, influence, support, aid (CISA), or the like, of
others. It also implies freedom from control or exercise of power.
There are two tenets of the concept of independence. These are:
(i) Independence in fact; and
(ii) Independence in appearance.
Independence in fact

This relates to independence of mind or mental attitude in matters relating to the engagement of a
professional. It pertains to the ability of the professional to offer professional advices without
fear or favour- without impairing the concept of objectivity or integrity.

Independence in appearance

This reflects the perception of users of financial statements about the professional involved in the
audit process. It relates to the extent to which issues of conflicting interest make users of
financial statements to suspect compromise of independence thus impairing integrity of audit
opinion. This aspect of the concept of independence makes it important that a professional must
avoid facts and circumstances that are so significant to make a reasonable and informed third
party to conclude that integrity, objectivity or professional skepticism had been compromised. It
forms the premise that the auditor must not only be independent, he must be seen to be so.

3.3Ethics of independence in relation to association with directors, shareholders

and clients

Components of professional ethic are many and may include:

(i) Honesty
(ii) Integrity
(iii) Independence
(iv) Transparency
(v) Accountability
(vi) Confidentiality
(vii) Objectivity
(viii) Respectfulness
(ix) Obedience to law.
Nonetheless, the professional code of conduct of the Institute of Chartered Accountants of
Nigeria (ICAN) listed some fundamental principles upon which the conceptual framework for
applying the principles by a professional accountant rest. These are: integrity, objectivity,
professional competence, confidentiality and professional behavior.

Association with directors, shareholders and clients are duty based and should be treated using
duty-based ethics which imply that an act is morally right if it respects and upholds rights. This
could be achieved by the auditor being of independent mind and of appearance. For this purpose,
the five sources of threats to independence identified by the institute should be eliminated
through:

(i) Avoidance of self-interest in financial matters with directors, shareholders and clients
(dsc);
(ii) Discouragement of self-review thus ensuring that financial statement prepared by the
auditing firm are not audited by it.
(iii) Assurance that if a listed company is the audit client, its shares are not promoted by
the audit firm.
(iv) Avoidance of familiarity between members of the audit firm’s family and directors,
key shareholders or the company itself. Example of an area to avoid includes a family
member working with a client or the company of a client.
(v) Avoidance of working for companies where directors or key shareholders are so
powerful as to constitute threat of possible loss of the engagement by the auditor
because of disagreement on professional issues.

3.4 Auditor’s responsibility to the profession, colleagues and the society .

Auditor’s responsibility to the profession

In the performance of his professional duties, an auditor has a number of responsibilities to the
profession. These include:

(i) Technical competence;

(ii) Compliance with extant rules and regulations;
(iii) Diligence in the performance of his duties;
(iv) Participation in continuous professional training programmes;
(v) Practicing ‘No direct advertisement[‘
(vi) Compliance with quality review of members or a professional body;
(vii) Responding to an inquiry or investigation by a member body or regulatory body; and
(viii) Compliance with ethical code of conduct.
According to the American Institute of Certified Public Accountants, the Independent Auditor
has a responsibility to his profesion: the responsibility to perform his duties in compliance with
with standards accepted by his fellow practitioners (AU 10:10). Consequently, the institute, like
ICAN in Nigeria, has adopted as part of its Code of Professional Conduct, rules supporting the
standards. Basis for their enforcement are also prescribed. The position of the global
accountancy ody, the International Federation of Accountants (IFAC) in this regard seems more
proactive. IFAC requires all its members bodies to implement a programme of audit monitoring
visit. This, ICAN has been doing since October 2009 through its ‘Practice Monitoring of Audit
Firms.’(The Nigerian Accountant Jan/March 2012 Vol. 45 no 1 p18&19)

Auditor’s responsibility to colleagues

An auditor’s responsibility to his colleahues include, but not limited to:

(i) Maintenance of high ethical standard;

(ii) When working for a client introduced by a sitting colleague, not accepting any offer
other than the assignment from his colleague from the client;
(iii) Compliance with rules relating to changes in professional appointment.

Auditor’s responsibility to the society

The main responsibility of an auditor to the society is the expression of an opinion on whether
financial statements and associated notes as prepared by the directors or those charged with
governance have been prepared in accordance with an appropriate financial reporting framework.
This opinion is more relevant in contemporary financial reporting environment which seeks to
address information deemed more relevant to users. To achieve the above, the auditor has to be
mindful of the following responsibilities towards the society:

(i) Maintenance of high ethical standard;

(ii) Maintenance of confidentiality of information obtained during the audit process
subject only to some recognized exceptions;
(iii) Not impeding the arrest of a client who commits an offence requiring arrest;
(iv) Disclosing information in public interest to the police especially, where litigations
arise.
It should be noted that audit opinion affect clients and many other members of the
society in many ways, especially in relation to making economic decisions. Also,
judgment of the auditor in the performance of his duties may further affect the
society, resulting into investigations which may be costly.

QUIZZES

1. In working life, there is always a war between the need for ………. and the desire for
gain –even where the gain is……...
 2. The ethical war of conflict is best fought with a ……….. to help professionals in making
…………… when faced with moral issues in work environments
3. Complete the following figure on ethics:

Ethics ……………

Codes ………….. Facing

Professionals Professionals

Service Crave for

……………
Ethics as a guide to moral values

4. An essence of professional ethics is to guide the use of ……… knowledge

5. Ethical codes of conduct which must be followed when …………… work.
6. ……… means freedom from control…………, support, aid (CISA), or the like, of others
7. Independence of mind or mental attitude in matters relating to the engagement of a
professional accountant is termed ‘…………………..’
8. The concept of objectivity or integrity is sustained in professional service through
independence in …………….
9. the premise that the auditor must not only be independent, he must be seen to be
independent relates to the concept of ,,,,,,,,,,,,,,,,,,,,,,
10. Three components of professional ethics include ......…, integrity and ………….

Quizzes from Quizlet.com

1. An ethical issue is a problem, situation, or opportunity
a. that has no correct answer.
 b. that harms the environment.
c. requiring society as a whole to choose among several actions that must be evaluated
as right or wrong.
d. requiring an individual, group, or organization to choose among several actions that
must be evaluated as right or wrong, ethical or unethical.
e. requiring an individual, group, or organization to choose between harming consumers
or the environment and earning more profits.

2. Ethical issues in business typically arise because of conflicts between individuals &
personal moral philosophies and values and the:
a. values and attitudes of the organization in which they work.
b. values and attitudes of the society in which they live.
c. values and attitudes of the organization in which they work and the society in which
they live.
d. laws and regulations of the country in which they live.
e. values and attitudes of their parents and religion.

3. _________ is an important element of virtue and means being whole, sound,

and in unimpaired condition.
a. Optimization
b. Ethical issue
c. Honesty
d. Trust
e. Integrity

4. A court found an oil company guilty of placing profits over the safety and well-
being of its employees. This situation can be classified as
a. ethical.
b. unethical.
c. an ethical issue.
d. a dilemma.
e. a justice issue.

5. A person uncomfortable with his employer & unspoken policy of hiring only white
men is experiencing
a. a conflict of interest.
b. an ethical issue.
c. a feeling of guilt.
d. cognitive dissonance.
e. a moral attribute.

6. Issues related to fairness and honesty may arise because business is sometimes
regarded as a:
a. legal case, where everything must be done to the letter of the law.
 b. contest, with the most ethical firm & quot; winning.& quot;
c. guerrilla war where anything goes in the fight for consumers & dollars.
d. game governed by its own rules rather than those of society.
e. game governed by the rules of society.

7. War metaphors are common in business. This kind of mindset can be dangerous
for business leaders because:
a. it may lead executives to become violent.
b. it may foster the idea that honesty is unnecessary in business.
c. it may lead organizations to be excessively aggressive.
d. business is not like warfare and the metaphors are not appropriate.
e. business is more like a game than a war.

8. Conflicts of interest exist when employees must choose whether to:

a. advance their own personal interests, those of the organization, or those of
some other group.
b. advance the interests of the organization or those of society.
c. accept bribes or not.
d. carry out an assignment they perceive to be unethical.
e. report an unethical coworker.

9. ____________ is the offering of something of value in order to gain an illicit

advantage.
a. Shoulder surfing
b. Hacking
c. Gift exchange
d. Conflicts of interest
e. Bribery

10. Concerns involving copyright infringement on books, movies and music, and
other illegally produced goods relate to which type of ethical issue?
a. Conflict of interest
b. Honesty
c. Communications
d. Discrimination
e. Intellectual property rights

Answers to Quizzes from Quizlet.com

 1. D
2. C
3. E
4. C
5. B
6. D
7. B
8. A
9. E
10. E

Allyssa Mcgranahan (2020) https://quizlet.com/347654798/ethics-chapter-3-flash-cards

Retrieved on May 14, 2020

REVISION QUESTIONS

1. (a) What is ethics?

(b) Explain how the concept of independence affects the perception of audit reports.
2. (a) Briefly distinguish between independence of fact and independence of appearance.
(b) State why an auditor must be independent in appearance.
3. (a) explain four responsibilities of the auditor to each of the following:

(i) The society;

(ii) His colleagues; and

(iii) The profession.

4. (a) Define professional ethics.

(b) With the aid of an appropriate diagram show the relationship between ethics, service
and crave for wealth in professional endeavors.
5. (a) One source of threats to independence identified by the Institute of Chartered Accountants
of Nigeria is maintenance of high ethical standards. Drawing inference the institute, explain how
the objective could be achieved.

Assignments

1. Read and summarize the following articles on ethic.

The 5 Biggest Ethical Issues Facing Businesses
From factory working conditions at the turn of the 20th century, to today’s emphasis on
diversity training, the history of workplace ethics is the ongoing story of the relationship
between employees and employers.

Ethical Issues in Business

According to the Global Business Ethics Survey of 2018 , employees (40%) believe that
their company has a weak leaning ethical culture, and that little progress has been made to
mitigate wrongdoing. Here are some of the ethical issues in business and real-world cases
of how these ethical issues have affected companies.

1. Accounting

“Cooking the books” and otherwise conducting unethical accounting practices is a serious
problem, especially in publicly traded companies. One of the most infamous examples is
the 2001 scandal that enveloped American energy company Enron, which for years
inaccurately reported its financial statements and its auditor, accounting firm Arthur
Andersen, signed off on the statements despite them being incorrect. When the truth
emerged, both companies went out of business, Enron’s shareholders lost $25 billion, and
although the former “Big Five” accounting firm had a small portion of its employees
working with Enron, the firm’s closure resulted in 85,000 jobs lost.

Although the Federal Government responded to the Enron case and other corporate
scandals by creating the Sarbanes-Oxley Act in 2002, which mandates new financial
reporting requirements meant to protect consumers, the “Occupy Wall Street” movement
of 2011 and other issues indicate that the public still distrusts corporate financial
accountability.

2. Social Media

The widespread nature of social media has made it a factor in employee conduct online
and after hours. Is it ethical for companies to fire or otherwise punish employees for what
they post about? Are social media posts counted as “free speech”? The line is complicated,
but it is drawn when an employee’s online activities are considered disloyal to the
employer, meaning that a Facebook post would go beyond complaining about work and
instead do something to reduce business.

For example, a Yelp employee wrote an article on Medium, a popular blogging website,
about what she perceived as awful working conditions at the influential online review
company. Yelp fired her, and the author said she was let go because her post violated
Yelp’s terms of conduct. Yelp’s CEO denied her claim. Was her blog post libelous, or
disloyal conduct, and therefore a legitimate cause for termination? In order to avoid
ambiguity, companies should create social media policies to elucidate what constitutes an
infringement, especially as more states are passing off-duty conduct laws that prohibit an
employer’s ability to punish an employee for online activities.

3. Harassment and Discrimination

Racial discrimination, sexual harassment, wage inequality – these are all costly ethical
issues that employers and employees encounter on a daily basis across the country.
According to a news release from the Equal Employment Opportunity Commission
(EEOC) , the EEOCC secured $505 million for victims of discrimination in private sector
and government workplaces in 2019. The EEOC states that there are several types of
discrimination , including age, disability, equal pay, genetic information, harassment,
national origin, race, religion, retaliation, pregnancy, sex and sexual harassment.

One type of discrimination, families responsibilities discrimination (FRD), has had an

increase in cases of 269% over the last decade, even as other forms of employee
discrimination cases have decreased. FRD is found in every industry and at every level
within the company, according to a 2016 report by the Center for WorkLife Law at the UC
Hastings College of Law. The report defines FRD as “when an employee suffers an
adverse employment action based on unexamined biases about how workers with
caregiving responsibilities will or should act, without regard to the workers’ actual
performance or preferences.” FRD includes many types of family responsibilities and
caregiving, including pregnancy and eldercare. For example, a father being fired for
wanting to stay home to care for his sick child, or a pregnant employee not being allowed
to take a break even though it was her doctor’s orders.

These cases are expected to continue to rise due to the growing number of family members
who have disabilities, the increase in people 65 and older who need care, the increase of
men who are becoming caregivers, and growing expectation for employees that they can
work and provide family care. Employers will need to adjust to these employee
perspectives and restructure how work can be accomplished to reduce FRD.

4. Health and Safety

The International Labour Organization (ILO) states that 7,397 people die every day from
occupational accidents or work-related diseases. This results in more than 2.7 million
deaths per year. According to the Occupational Safety & Health Administration, the top
10 most frequently cited violations of 2018 were:

1. Fall Protection, e.g. unprotected sides and edges and leading edges
2. Hazard Communication, e.g. classifying harmful chemicals
3. Scaffolding, e.g. required resistance and maximum weight numbers
4. Respiratory Protection, e.g. emergency procedures and respiratory/filter equipment
standards
5. Lockout/Tagout, e.g. controlling hazardous energy such as oil and gas
6. Powered Industrial Trucks, e.g. safety requirements for fire trucks
7. Ladders, e.g. standards for how much weight a ladder can sustain
8. Electrical, Wiring Methods, i.e. procedures for how to circuit to reduce
electromagnetic interference
 9. Machine Guarding, e.g. clarifying that guillotine cutters, shears, power presses and
other machines require point of operation guarding
10. Electrical, General Requirements; i.e. not placing conductors or equipment in damp
or wet locations

Physical harm isn’t the only safety issue to be aware of, though. In 2019, an ILO report
focused on rise of “psychosocial risks” and work-related stress. These risks, which
include factors like job insecurity, high demands, effort-reward imbalance, and low
autonomy, have been associated with health-related behavioral risks, including a sedentary
lifestyle, heavy alcohol consumption, increased cigarette smoking, and eating disorders.

5. Technology/Privacy

With developments in technological security capability, employers can now monitor their
employees’ activity on their computers and other company-provided electronic devices.
Electronic surveillance is supposed to ensure efficiency and productivity, but when does it
cross the line and become spying? Companies can legally monitor your company email and
internet browser history; in fact, 66% of companies monitor internet
connections, according to 2019 data from the American Management Association . 45% of
employers track content, keystrokes and time spent on the keyboard, and 43% store and
review computer files as well as monitor email. Overall, companies aren’t keeping this a
secret: 84% told employees that they are reviewing computer activity. Employees should
review the privacy policy to see how they are being monitored and consider if it can
indicate a record of their job performance. s Facing Businesses

https://www.floridatechonline.com/blog/business/the-5-biggest-ethical-issues-facing-businesses/

Retrieved on May 14, 2020

Ethical issues encountered by accountants

By
Curated Content
-
Jul 13, 2017

The King Report on Governance for South Africa recommends that the boards of
companies should ensure that the company’s ethics is managed effectively.

But how does it impact on accountants if ethical guidelines are not adhered to?

No one will disagree that ethical behavior is necessary in the accounting profession,
as the consequences of unethical behaviour by accountants can be disastrous for
the companies concerned, as well as for the accountants themselves.

Often though, accountants are pressured into unethical behaviour by management,

even if it simply is to make the company’s performance look better by moving
revenue entries from one year to another.

In an article in the Houston Chronicle, author Jonathan Lister describes ethical

issues frequently encountered by accountants:

Pressure From Management

The burden for public companies to succeed at high levels may place undue stress
and pressure on accountants creating balance sheets and financial statements. The
ethical issue for these accountants becomes maintaining true reporting of company
assets, liabilities and profits without giving in to the pressure placed on them by
management or corporate officers. Unethical accountants could easily alter
company financial records and maneuver numbers to paint false pictures of
company successes. This may lead to short-term prosperity, but altered financial
records will ultimately spell the downfall of companies when the Securities and
Exchange Commission discovers the fraud.

Accountant as Whistleblower
An accountant may face the ethical dilemma of reporting discovered accounting
violations to the Financial Accounting Standards Board. While it is an ethical
accountant’s duty to report such violations, the dilemma arises in the ramifications
of the reporting. Government review of company financial records and the bad
press caused by an accounting scandal could cause the company’s rapid decline and
may lead to the layoff of thousands of employees. Executives and other corporate
officers could also face criminal prosecution, leading to heavy fines and prison time.

The Effects of Greed

Greed in the business and finance world leads to shaving ethical boundaries and
stepping around safeguards in the name of making more money. An accountant can
never let the desire to earn a better living and acquire more possessions get in the
way of ensuring that she follows ethical guidelines for financial reporting. An
accountant who keeps her eyes on her own bank account more than on her
company’s balance sheet becomes a liability to the company and may cause real
accounting violations, resulting in sanctions from the SEC.

Omission of Financial Records

A corporate officer or other executive may ask an accountant to omit or leave out
certain financial figures from a balance sheet that may paint the business in a bad
light to the public and investors. Omission may not seem like a significant breach of
accounting ethics to an accountant because it does not involve direct manipulation
of numbers or records. This is precisely why an accountant must remain ethically
vigilant to avoid falling into such a trap.

https://accountingweekly.com/ethical-issues-encountered-accountants/

Retrieved on May 14, 2020

Proven ways to instill ethics in companies

By
Curated Content
-
Feb 28, 2017

Many corporate scandals can be cited as examples of business leaders allowing

(knowingly or not) unethical behavior to take root in their organisation’s culture.

The public fallout from these scandals reinforces that acting ethically is as important
and material to a company’s performance as ensuring the financials are unequivocally
accurate.

In no department is it more important to instill ethical behavior than accounting and

finance, says Prof. Curtis C. Verschoor from DePaul University and Chair-Emeritus of
the IMA’s Committee on Ethics. “The nature of the work carried out by accountants
requires it. Management, shareholders and potential shareholders, and creditors and
potential creditors rely on their work to present a true and fair view of the company.
Incorporating ethics guidelines in an employee handbook, as is the common strategy, is
insufficient.” The key according to Verschoor is proper teaching of ethics is the key.

He suggests the following ways for accounting and finance leaders to ensure their
employees act with the utmost integrity.

Set an example

Possibly the most crucial way to instill ethics in an organisation is to lead by example—
confirming that the expectation of good conduct is followed at all levels. How you, as a
leader, express these policies and procedures depends on the size of the company, but
it is everyone’s job to communicate when something does not look or feel right. With a
strong ethical culture, no one should fear retaliation for speaking up.

While there are many consultants and so-called ethics experts, nothing beats the CEO
as the best person to lead and teach employees about the importance of ethics, and
more importantly, how ethics relates specifically to your company.

In practice this can mean involving the CEO or finance leader in ethics workshops
covering actual circumstances that affect your company or industry. This works
especially well in small to midsize companies but can also work in larger firms.
Reinforce core principles and values

An explanation commonly cited after ethical scandals are uncovered is that the guilty
party simply did not know they were expected to conduct themselves ethically. For
example, in the Wells Fargo “fake accounts” scandal, employees creating the accounts
believed their highest priority was making their quotas versus acting ethically. The IMA
Statement of Ethical Professional Practice sets forth four ethical principles to guide any
company’s methods of operation: honesty, fairness, objectivity and responsibility.
These principles should be written with more specific examples in the form of a “code of
conduct,” widely circulated to employees, investors (if any), creditors, suppliers and the
local community and continuously reinforced by senior leadership teams.

Establish the right tone

While finance leaders can ensure all stakeholders are acting ethically, it is also critical
to communicate ethical beliefs and expectations in the appropriate tone.

Building trust is critical, and communication helps achieve that goal. However, this
approach only works if the leadership team really believes in ethics, lives it and embeds
the practices, which implies the organisation has invested the time and energy in
developing core values. For this reason, the urgency behind the leadership team
embodying ethical practices cannot be stressed enough.

A seed of unethical behaviour can grow and eventually upend or destroy a company. To
avoid scandals and misconduct, finance professionals must embrace ethical practices,
and then communicate their vision to the rest of the company.

https://www.accountingtoday.com/opinion/proven-ways-for-accountants-to-instill-
ethics-in-companies

Retrieved on May 14, 2020

2. (a) Identify two ethical issues in the fight against covid-19.

(b) Suggest how the problems identified could be solved.

3. Explain you intend to resolve issues of professional ethic when you commence your career as a
professional accountant.
 4.0 CHAPTER FOUR
AUDITOR’S LIABILITIES

At the end of this lecture, students are expected understand auditor’s liability.
Specifically, they should be able to:
4.1 Define liability

4.2 State the source of liability

4.3 Explain liability for negligence under common law

4.4 Explain liability under statute- Civil and Criminal Law

4.5 Discuss recent developments in third party liability

 4.1 Definition of liability

Liability is a debt or obligation which arises during the course of business operations.
They are settled over time by transferring economic benefits including money, goods
or services (investopedia).
It is also a duty or responsibility to others that entails settlement by future transfer or
use of assets, provision of services.
The auditor’s liability, hence, is his debt or obligation to the client and possibly third
parties relating to his work where fraud or negligence is established in the
performance of his duties.

4.2The source of liability

The main source of liability in relation to the auditor is rhe role he plays in 8n the
attestation of the financial statements. Liability, hence, arises from the
performance of his duties to the client and third parties who may rely on his
attestation moreso when unmodified report on a given set of financial statements
are deemed to be misleading. The implication of this is that there is public interest
in the effective performance of the audit functions as it serves ‘a fundamental
purpose in promoting confidence and reinforcing trust in financial information.’
(icaew.com…..role-of-audit.pdf).
Liability may therefore arise under :
(a) Common law;
(b) Statutory Law which may be:
(i) Civil; or
(ii) Criminal
Liability under Common Law

Common laws are un enacted laws. They are generally accepted norms such as the need to
exercise a duty of care of in the performance of professional duties. In the case of Formento
Starling Area Ltd v Selsdom Fountain Pen Co Ltd., for example, Lord Denning ruled that
auditors were not confined to mechanics of professional adding and subtracting of financial
figures. Rather they must be of inquiring mind thus checking properly to ensure no mistakes
arise in the financial statements audited by them.
 Liability under Statutory Laws

Statutory laws are written laws created by state or federal legislative bodies. Therefore, liability
under statutory laws arises from federal and state laws, such as the Companies and Allied
Matters Act (CAMA) 1990. It may also arise from regulatory bodies such as the Security and
Exchange Commission (SEC) as provided in the Investment and Securities Act (ISA) 2007.

4.3 Liability for negligence under Common Law

Under common law, liability may arise from fault on the part of the auditor to the client or third
party.

Liability to Client

This may relate to:

a) Negligence;
b) Breach of contract; or
c) Fraud.

Liability to Third Party

a) Ultramares doctrine; or
b) Foreseen users.
Liability for negligence

Negligence may be viewed as failure to exercise due professional care. It may ordinary
negligence or gross negligence. Ordinary negligence implies failure to perform duty according to
applicable standards while gross negligence relates to the insensitivity of the auditor to the
possible injuries that may result from failure to perform duties with care.

Negligence may relate to both third parties and clients.for a client to recover from an auditor
under common law, he must prove duty, or breach of duty of care, losses, and that the losses
resulted from the lack of duty of care in the discharge of auditing functions (causation)..
4.4 Liability under Statute – Civil and Criminal Laws

Liability under statute relate to obligations that arise from a particular statute or a law. They
include securities and other regulatory laws. The statutoey liability usually provides cover for
defense costs, fines and penalties charged against erring auditors. Liabilities under this category
may be:

(a) Civil; or
(b) Criminal.
Civil Liability

This relates to issues arising from breach of contract. It may occur where a company suffers loss
or damage as a result of the failure of the auditor to discharge the fiduciary duty imposed on him
satisfactorily. The statutory source of auditor’s liability in Nigeria is section 368 of the
Companies and Allied matters Act (CAMA) 1990. It states that the auditor could be liable for
negligence and the directors may institute an action against himin the court. Also, if a company
is winding up, a negligent auditor may be treated as an officer of the company.

Liability under Criminal Law.

Criminal laws relate to crime with criminal intention. An auditor may be found gfuilty of
criminal liability in circumstances where fraud or other losses are established against him in the
performance of his duties provided that the act was committed knowingly or recklessly. Criminal
law liabilities therefore, occur when the auditor commits an act resulting in losses or fraud with a
guilty mind.

In Nigeria, legal sources of criminal liability are:

(i) Section 643 (2) of CAMA 1990; and

(ii) Section 436 of the Nigerian Criminal Crime Code.
The operation of both common law and statutory law plays dominant roles in influencing the
roles and the duties of auditors as well as regulatory reforms in recent time.

4.5 Recent Developments in Third Party Liability.

A third party is a person to whom the auditor has no contractual relationship. Under the contract
law, a person who is not privy to the contract cannot sue for non-performance. This explains why
CAMA provides in s. 648 for the directors to sue on behalf of the company. The implication of
this is that only the company that employed an auditor may sue him for non performance: not
even the directors on their own recognition. In recent times, however, third parties have
successfully sued auditor. The table below provides a sample of such cases.

Some cases where third parties successfully sued auditors – Australian example.

Third Party Auditor Settlement Paid ($)

1. Linter Group Price Waterhouse 320m
2. Australian Security & Deloitte for faulty audit of
Investment financial statements.
Commission (AISC) $340m
on behalf of Adelaide
Streamship- 1996.

3. Victorian Government Peat Marwick Hungerfords in $136m

relation to audit of
Tricontinental Bank

Theories favouring auditor’s liability to third parties.

Some theories seem drive the clamour for auditors liability towards the third party. Two of these
are the expectation gap theory and the deep pocket theory.

Expectation Gap

Expectation gap mirrors the distinction between what the client perceive to be the duties and
responsibilities of an auditor and what auditors and the profession assume such duties to be. For
example, clients often postulate that one duty of the auditor in the performance of his attestation
duties is to detect fraud. This negates the stand of auditors and the profession which posits that
detection of fraud is merely incidental to auditing functions rather than being the prime focus.

Consequent upon the expectation gap, business failures are wrongly treated as audit failure
especially where corporate enties fail and are liquidated.Furthermore, third parties blame
auditors for failure of directors to and those charged with governance to provide resilient internal
control systems and good corporate ethics to drive optimal financial performance and reduced
incidents of fraud. Moreover, one point often lost to champions of the expectation gap is the fact
that auditors do not provide absolute assurance. Rather auditors provide reasonable assurance
within the generally accepted auditing procedures.

Deep Pocket Theory

This theory seem to imply that since most companies may not be financially strong enough to
meet liabilities arising from non performance, focus must shift to auditors deemed negligent in
the performance of their duties thus causing either corporate distress or corporate failure. This
stems from the knowledge that auditing firms usually maintain indemnity insurance which may
run into billions of naira and so, may be in a better position to settle liabilities established for
negligence. In the circumstance, the depths of the financial pocket of auditors serve as a good
attraction for third party litigation.

Recent Efforts to Limit Auditors liability to Third Parties

In recent times, various efforts have been made to limit the liability of auditors to third parties.
One of such is the institution of proportional liability as well as introduction of statutory capping
– currently an international trend. Other measures include: recognition of liability to shareholders
as a whole rather than individual shareholders; liability being definite and not extending to
indeterminate level; not extending liability beyond privity except in case of gross negligence
amounting to fraud.

Note:

In relation to common law tort of negligence

There must be : A duty of care

: A breach of the duty

: Damage caused by the breach.

See an analysis of the auditors’ liability to third parties in Australia by Vylan Nsuyen and Pelma
Raja Pakse.

QUIZZES

1. ………………is a debt that must be …………….or ……………that must be fulfilled.

2. Sources of liability include common law and……………..
 3. A law, codified in an Act of the National Assembly is called………………….
4. Section 368 of the Companies and Allied Matters Act (CAMA) 1990 deals with ………..while
section ………………….deals with criminal acts.
5. Theories that favour audit expectation gap include ………..and…………….

REVISION QUESTIONS

1. (a) Explain the main source of civil liabilities to an external auditor in Nigeria.
(b) State three procedures which an auditor must execute to avoid possible litigation arising
from civil legal actions.

2. (a) Briefly define liability.

(b) List two types of liability to which a auditor must aware.
(c ) Differentiate between liabilities identified in (b) above.

3. Discuss how you as an auditor may protect your firm, Jagun and Associates, from
liabilities arising from the performance of your duties to clients.

4. (a) Explain the relevance of the principle of privity in claims for negligence in external auditing.

(b) With two good examples resting on decided cases, show the futility of the principle
explained above in practice.

5. (a) Briefly distinguish between criminal liability and civil liability.

(b) With reference to the Companies and Allied Matters Act (CAMA) 1990, explain how a
shareholder may sue an external auditor for negligent performance

ASSIGNMENT

1. Obtain copies of;

(i) Companies and Allied Matters Act (CAMA) 1990
 (ii) Companies and Allied Matters Act (CAMA) 1990

2. Study sections 368 and 643 of CAMA 1990

(a) Summarize each of the sections.
(b) Differentiate between the sections.

3. Discuss the distinction between common law and statutory law.

 5.0 CHAPTER FIVE

APPOINTMENT AND REMOVAL OF AUDITORS

At the end of this lecture, students are expected understand yhe appointment and
removal of auditors. Specifically, they must be able to:
5.1 Explain the procedure for the appointment and removal of auditors –legal and other requirements

5.2 State the procedure for fixing the remuneration of auditors

5.3 State the qualification of an Auditor as distinct from that of Accountants

5.1 The procedure for the appointment and removal of auditors –legal and other
requirements

The procedure for the appointment and removal of auditors is provided in the Companies and
Allied matters Act (CAMA) 1990 as well as the Articles and Memorandum of Association of
each corporate entity. Such appointment could be either by the company or by the directors.

Appointment by the company

The procedure for the appointment of an auditor by the company is provided for in section 357
(5) of CAMA 1990. For a new company, an auditor could be appointed prior to the first annual
general meeting at a general meeting conveyed for the purpose where the directors fail to
exercise their power under section 357(5). Also by section 364(1b) the company could appoint
an auditor to fill a temporary vacancy. The company may also re-appoint a retiring auditor or a
new auditor for an on-going concern.

Appointment of an Auditor by the Directors of the Company

Appointment by directors could be prior to the first annual general meeting or to fill a temporary
vacancy. The appointment must be confirmed at the annual general meeting subsequent to the
appointment.

Removal of auditors

This is by virtue of sections 362 and 364 of CAMA.

5.2 Procedure for fixing the remuneration of auditors

This depends on who appoints the auditors.

If the auditors were appointed by the directors, then the remuneration may be fixed at by the
directors or by the company at general meeting (s.361)

If the auditors were appointed by the company, then the remuneration may be fixed at any
general meeting or as the company may decide in a general meeting.
Procedure

This may be as follows:

(i) The directors identify auditors for the company;

(ii) Subject to the acceptance of the offer to be engaged, the auditor is engaged;
(iii) The engagement specifies the scope of work to be done and the remuneration;
(iv) The auditors are presented at annual general meeting or a general meeting called for
that purpose for ratification by the company.
4.3 Qualification of an Auditor as distinct from an Accountant.

Section 358 of CAMA 1990 details the qualification of an auditor. This includes:

(i) Membership of a body of Accountants in |Nigeria established by an Act.

(ii) Not being an officer or servant (e.g employee) of the company.
(iii) Not being a partner or employee of an officer of the company.
(iv) Not being a body corporate.
(v) Not being a person or firm who or which offers to the company professional advice in
a consultancy capacity in respect of secretarial, taxation or financial management.
(vi) Not being anyone disqualified under (i) or (ii) from being the auditor of another
company in the same group (i.e a holding company, subsidiary or fellow subsidiary).

All these provisions do not pertain to an Accountant of the company who is an officer
of the company and may not necessarily belong to a body of professional accountants.
Even where such a person belongs to a body of professional accountants like the
Institute of Chartered Accountants of Nigeria, have a practicing certicate is not
mandatory as it is for practicing auditors. Furthermore, the requirement for
monitoring auditors as prescribed by the International Federation of Accounts do not
affect accountants.

QUIZZES
1. The procedure for the appointment and removal of auditors is provided in the Companies
and Allied Matters Act (CAMA) 1990 as well as the Memorandum and Articles of
Association of each corporate entity.
2. Appointment of an auditor could be either by the …………… or by the …………
3. Section …………….of CAMA 1990 deals with appointment of auditors while section 362 deals with
…………………of the auditor.
4. CAMA 1990 is definite about the qualification of an auditor as evidence in section …………
5. The section of CAMA 1990 dealing with remuneration of an auditor is …………………….

REVISION QUESTIONS

1. Briefly state two differences and two similarities between the appointment and the
removal of an auditor of a limited liability company.

2. Justify the need for a special notice in the procedure for the removal of an
external auditor.
3. (a) Enumerate the procedure for appointing the auditor for Kudere Ltd., a
company formed on January 1, 2020 before July 28, 2020 when it plans to
commence business operation.
(b) Indicate who fixes the auditor’s remuneration.

4. Following a successful completion of the mandatory practical experience required for

issuance of practicing certificates to members, the Institute of Chartered Accountants of
Nigeria (ICAN) delivered unto you, practicing certificate of the Institute on July 1, 2019.
Prior to that period Yankudi Limited, Wukari had been interested in appointing you as
an External Auditor to the company, effective from January 1, 2020. Required:

(i) Briefly explain why you were unable to accept the offer before issuance of
the practicing certificate;
(ii) State two other qualifications which must be fulfilled before perfecting the
engagement letter.

5. Discuss the procedure for removing an external auditor.

6. (a) Explain the procedure for the appointment the first auditors of a newly incorporated
company.
(b) Justify the need for the remuneration of such auditors.

ASSIGNMENTS

1. Visit a limited liability company of your choice and inquire about:

 (a) How auditors are appointed in the company;
(b) How auditors are removed in the company; and
(c) How remuneration of auditors are determined in the company.
Submit a brief report on the above.

2. Summarize the following sections of the Companies and Allied Matters Act (CAMA) 1990.
3. Tabulate differences between the following sections of CAMA 1990.

Sections Differences

357 and 362

361 and 364

4. Visit a Court of law within Ikeja for two weeks.

(a) Analyze the percentage of cases relating to negligent performance by auditors.
(b) Comment on the prevalence of section 368 of CAMA 1990 in Nigerian business
environment.
5. Visit a limited liability company of your choice and write on the provisions of their
memorandum of association and articles of association regarding:
(i) Appointment of auditors;
(ii) Removal of auditors;
(iii) Remuneration of auditors;
(iv) The extent to which the wife of the Managing Director could perform statutory
audit functions.
 6.0 CHAPTER SIX
THE INTERRELATIONSHIP OF THE AUDIT FUNCTIONS AND THE
INTERNAL CONTROL SYSTEM
At the end of this lecture, students are expected to be able to:
6.1 Define internal Control, Internal Audit and Internal Check

6.2 Explain the significance of an audit assignment

6.3 Explain the characteristics of internal audit functions and internal control questionnaires

6.4 Explain the significance of internal audit functions and internal control questionnaires in an audit

6.5 Explain the significance of strong internal control systems

6, 1 Definition of Internal Control, Internal Audit and Internal Check
Internal control, internal audit and internal check are related in that effective internal
control is achieved through efficient internal audit and internal checks. The
relationship may be expressed as shown below.

Interrelationship between internal control, internal audit and internal check

Internal Control System

Internal Internal

Checks Audit

Figure 6.1

Definition of Internal Control Systems

Internal control systems are the processes within a department or organization which
aim at providing reasonable assurance relating to the achievement of organization
objectives. Such objectives may include:
(i) Reliability and integrity of information;
(ii) Compliance with policies, plans, procedures, laws and regulations;
(iii) Safeguard of assets;
(iv) Economical and efficient use of resources;
(v) Effectiveness and efficiency of operations;
(vi) Reliability of financial reporting; and
(vii) Reliability of operational reporting.
 Definition of Internal Audit
Internal audit is the process of evaluating the business processes and procedures to
assess the effectiveness of control systems and recommending solutions to eliminate
the weaknesses or reduce them to a level of insignificance. Therefore, internal audit
enhances operational efficiency, accuracy, as well as reliability of financial data.

Definition of Internal Checks

Internal checks are indicating checks on routine basis aimed at proving the work of
one personnel against the other. This enhances early detection of errors and may
indeed, lead to total prevention of errors and the incident of fraud. Internal checks are
a part of the internal control system. They assure the efficiency of the accounting
system.

Interrelationship between Internal Audit, Internal Check and Internal Control functions

Internal Corporate --
evaluates - Objectives:
Audit processes to reliability &
eliminate weaknesses Internal
integrity of
Enhance
Control financial
Attainment of
Systems information;
errors
detected early
-Compliance
Internal
or totally prevented with
Checks regulations
etc
Figure 6.2

6.2 Significance of Audit Assignment

Internal audit assignment is usually focused on the operational effectiveness of control systems
used within an organization. Such assignment normally acquires more detailed knowledge of the
systems operating in the organization than the external or statutory auditing. This is because
more extensive review could be undertaken using appropriate internal control questionnaires.
Consequently, it could detect dysfunctional systems on time and recommend remedial actions
before havoc is done. Internal audit also helps to minimize errors, misrepresentations,
misstatements and fraud where it is reasonably undertaken. Also, it helps to reduce substantially,
the time and cost of external auditing.

6.3 Characteristics of Internal Audit Functions and Internal Control Questionnaires .

As noted in 6.2, one instrument of executing internal auditing function is th Internal Control
Questionnaire (ICQ). This section explains the characteristic of both the internal audit function
and the internal control questionnaire.

Characteristics of Internal Audit Functions

The internal audit function is like a consultancy service rendered by one section of an
organization to other parts of the organization. It characteristics may be explained in terms of its
nature, design, operation, commitment, scope, limitation and report among other attributes as
tabulated in figure 6.3

. Characteristics of Internal Audit Functions

Attributes Characteristic
1. Nature It is an independent, objective assurance and consulting activity
2. Design It is designed to add value to an organization thus improving its
operations
3. Operation It operates across the entire organization. Such operation helps the
organization to achieve its objective by encouraging a systematic,
disciplined approach the evaluation of the effectivess of risk
management, control and governance processes in an organization.

4. Commitment It is committed to attributes such as integrity and accountability

among others.

5. Scope Tis is within the organization and is broad. It may include areas such
as efficiency of operations, reliability of financial reporting, detecting,
deterring and investigating fraud, safeguarding assets and compliance
with laws and regulations.

6. Limitations Its functions are not responsible for the execution of corporate plans.
Rather such functions are advisory. It follows, hence, the
recommendations may not be adopted or hardly valued especially
when the internal auditor occupies a low level in the organizational
hierarchy.

7. Reports Internal auditing functions are reported to the highest decision maker
or to those charged with corporate governance such as the Audit
Committee (AC). This ensures independence from operational
 management. Cases of management insensitivity to audit reports may
still not be ruled out, though.

Characteristics of Internal Control Questionnaires (ICQs)

An ICQ is a formal and usually standardized document used to obtain

relevant information about an entity or an aspect of its operations.

Characteristics of Internal Control Questionnaire

Attributes Characteristic
1. Nature It is a tool for obtaining desired information about an entity or
a specific subject matter
2. Design It is designed in structured way thus making the process of
information gathering more convenient.
3. Operation It operates across the entire organization and could be used to
obtain information about the board as well as the various
operational activities of the entity. These may include
collection of information on purchasing procedure, sales
procedures, effectiveness of established controls and measures
for process enhancement

4. Commitment It is committed to attributes such as effectiveness of

established internal control systems and how deviations are
addressed.

5. Scope It is within the organization and is broad. It may include areas

such as efficiency of operations, reliability of financial
reporting, detecting, deterring and investigating fraud,
safeguarding assets and compliance with laws and regulations.

6. Limitations Its functions are dependent on responses obtained from third

parties or personal observation. The quality of information
obtained and control measures evolved depend on the dexterity
of the designer and administrator of the questionnaire..

7. Reports ICQ information is reported to the line manager for instant

remedial action. For strategic controls, report may be to the
highest decision maker or to those charged with corporate
governance such as the Audit Committee (AC). This ensures
that deviations are corrected on time.
 6.4 Significance of Internal Audit Functions and Internal Control Questionnaires in an Audit.

6.4.1 Significance of Internal Audit Functions in an Audit.

The Institute of Internal Auditors (IIA) defines Internal Auditing as:

“An independent, objective assurance and consulting activity designed to

add value and improve an organization’s operations. The internal audit
activity helps an organization accomplish its objectives by bringing a
systematic, disciplined approach to evaluate and improve the effectiveness
of risk management, control and governance processes.”

Specifically, the significance of Internal Audit Functions in an Audit include

Providing management with information, appraisals, recommendations, and

counsel regarding the activities examined and other significant issues.

Executing an approved audit plan; and

Performing the following tasks in accordance with its overall strategy:

 Verify the existence of assets and recommend proper safeguards for their
protection;
 Evaluate the adequacy of the system of internal controls;
 Recommend improvements in controls;
 Assess compliance with policies and procedures and sound business
practices;
 Assess compliance with state and federal laws and contractual obligations.
 Review operations/programs to ascertain whether results are consistent
with established objectives and whether the operations/programs are being
carried out as planned;
 Investigate reported occurrences of fraud, embezzlement, theft, waste, etc.

6.4.2 Significance of Internal Control Questionnaires in an Audit.

The significance of ICQs include:

(i) survey of internal controls systems in existence;
(ii) Highlighting any weaknesses in the control systems;
(iii) Usefulness in designing audit approach;
(iv) Ensuring due focus on internal control to minimize dysfunctions and
process disruptions; and
(v) Applicability in complex corporate audit engagements.

6.5 Significance of Strong Internal Control Systems

As shown in figure 6.1, internal control systems (ICS) comprises of internal audit functions and
internal checks. Therefore, strong internal control systems ensures that corporate objectives are
achieved most efficiently and effectively. They also ensure that major control units are working
efficiently thus minimizing risks of misstatement and improving the integrity of the financial
statements.

Moreover, because of the shift in auditing approach from procedural to risk-based approach, a
strong internal control system will enhance placing greater reliance on a firm’s internal
compliance with rules and regulations as well as with control systems rather than top-to-bottom
examinations during external auditing, it follows, hence, that in a risk-based- auditing system, a
strong internal control system will address issues like:

(i) Existence and effectiveness of requisite internal control systems;

(ii) Systems working as desired;
(iii) Identifying and resolving exceptions and problems promptly;
(iv) Procedures being followed are provided in writing and made available to appropriate
personnel;
(v) Staff being well trained in the implementation of procedures to identify dysfunctional
systems; and
(vi) Documenting remedial actions taken to resolve identified problems.
More importantly, in large organizations where every aspect of the business could not be
reviewed during final audit or external auditing, strong internal control also facilitates the risk-
based auditing and transactional testing. It promotes confidence by the auditor and regulators in
corporate systems between examinations.
QUIZZES

1. An internal control system includes…………l audit and internal check

2. Internal control systems are the …………. within a department or organization
aimed at providing reasonable assurance relating to the achievement of
………………
3. Internal checks are indicating checks on …………… basis aimed at proving the
work of ………… against the other.
4. Internal checks enhance ……….. and may lead to total prevention of errors and
the incident of ………. It is a part of the ………...
5. Internal checks assure the ……………of the accounting system.

REVISION QUESTIONS

1. Explain how internal control systems reinforce risk-based audit.

2. State five issues which internal control systems may address in a risk-based auditing
system.
3. Briefly explain the significance of strong internal control systems in the audit of:
(i) UAC Plc.;
(ii) Jennifer Nigerian Enterprises; and
(iii) Lagos City Polytechnic.
4. What is the significance of an internal control questionnaire in an audit?
5. State five known characteristics of internal audit functions and three characteristics of
internal control questionnaire.
6. (a) What is an internal audit assignment?
(b ) Explain three benefits of an internal audit assignment.
7. With regards to auditing, define the following term:
(a) Internal Control Systems
(b) Internal Audit Functions.
(c) Internal Checks.
8. Using a simple sketch, show the relationship between the elements in 7 above.
Reference

1. NSA 1
 2. NSA 3
ASSIGHMENTS

1. Visit ten companies in your locality.

2. Indicate how many of the entities visited operate an internal audit department and
write on the perception of the entity on internal audit functions.
 CHAPTER SEVEN

SELECTION OF AREAS OF WORK CONTROL, IN-DEPTH TESTS, USE OF

GRAPHS, AND SAMPLING TECHNIQUES

At the end of this lecture, students should know selection of areas of work control, in-depth tests, use of
graphs, and sampling techniques. In particular, they should be able to:

7.1 Define work control, in-depth graphing and sampling techniques

7.2 State the significance of organizational charts and flow charts in an audit procedure for work control,
in-depth graphing and sampling techniques.

7.3 Explain the testing of the system of internal control, compliance tests, transaction tests and

functional test.
7.1 Define work control, in-depth graphing and sampling techniques

7.1.0

This lesson introduces students to the rudiments of planning and performance of audit functions.
Auditing under the ‘systems auditing’ approach is designed to achieve its goal by examining , testing and
evaluating the accounting procedure of the client to enable the auditor to assess the extent of reliance
to be placed on the accuracy of financial statements presented to him for auditing.

7.1.1 Work control

Work control may be defined as the examination, testing and evaluation of the accounting procedure of
the client to enable the auditor to assess the extent of reliance he could place on the accuracy of
financial statements presented to him by the client for auditing. This area depends on the strength of
the internal control system. If the internal control system is deemed weak, a large area may be selected
for testing. This may also require in-depth testing or further audit procedures.

In the performance of his duty, the auditor must understand the entity and its environment which
includes its internal control and assessment of the risks of material misstatement as described in the
Nigerian Standard on Auditing (NSA) 9. (Understanding the Entity and Its Environment and Assessing the
Risks of Material Misstatements). Therefore, using Risk-Based Auditing Approach, work control areas
relative to reduction of audit risks to acceptably low level entails the auditor following the relevant NSA
such as NSA 11 on the Auditor’s Procedures in Response to Assessed Risks. The standard states that in
order to reduce audit risks to an acceptably low level, the auditor should:

(i) Determining overall responses to assessed risks at the financial statement level;
(ii) Respond to assessed risks at the assertion level by designing and performing further audit
procedures.
The standard further states that the overall responses and the nature, timing and extent of the further
audit procedures are matters of professional judgment. This implies that the auditor must use
professional judgment relative to each assignment. It also implies that consideration of his responsibility
to the possibility of fraud in the financial statements as guided by NSA 5: “The Auditor’s Responsibility to
Consider Fraud in an Audit of Financial Statements” must be held in high esteem.

7.1.2 In-depth graphing

In-depth graphing relates to using charts such as flow charts to analyze the accounting and internal
control systems of an entity. Usually, the accounting routines are broken into appropriate sub-divisions
for ease of comprehension. Some of the sub-divisions of the accounting system may be as follows:

(i) organizational and general matters;

 (ii) purchases and trade creditors;
(iii) stocks;
(iv) payroll;
(v) sales and debtors;
(vi) receipts and payments;
(vii) bank and cash balances;
(viii) investments;
(ix) Investment income.
Evaluation of internal controls built into the accounting systems may not be so easy to accomplish. This
is because most methods of documentation like systems notes, descriptive internal control
questionnaires (ICQ) specifically seldom identify controls. This gap is often filled by the use of flowcharts.
Nonetheless, this requires an experienced systems auditor to correctly identify possible areas of
weaknesses thus assessing the degree to which necessary controls are adequate. Three main controls
recognized by de Paula and Artwood (p 40,72) are management controls, organizational controls and
procedural controls. Flowcharts are extensively used to evaluate these controls. The overall outcome of
the evaluation of the internal control systems is the decision on the nature of the audit tests required
for the specific circumstances.

7.1.3 Sampling Techniques

Other judgment to be made by the auditor includes the extent of tests to be applied and the
methodology to be adopted in selecting the work area (samples). Such selection may be premised on
either of two approaches: random sampling and personal judgment.

Sampling is statistical procedure which helps an auditor to draw inference from a given population by
studying a scientifically selected number items or members from the population. It is a procedure that
allows conclusions to be made about a large group by examining a sample of the group. In auditing for
example, it is the procedure that enables the auditor to form an opinion and conclude on a group of
accounts such as creditors by examining a selected number (sample) of the creditors for detailed
analysis. Such samples are deemed to be representative of the population and are also assumed to be
error free.

In Risk-based Auditing (RBA), in-depth analysis may relate to consideration of the nature, timing and
extent of further audit procedures.

NSA 12: THE AUDITOR’S RSPONSES TO ASSESSED RISKS

Levels of risk

(i) Financial statement - determine overall responses to assessed risks at this level.
(ii) Assertion –design and perform further audit procedures to respond to assessed risks at this
level.
Determine overall responses to assessed risks
 - Risk of material misstatement at the financial statement level
Reponses may include:

(i) Maintenance of professional skepticism in gathering and evaluating audit evidence;

(ii) Assigning more experienced staff or experts;
(iii) Providing more supervision;
(iv) Incorporating more elements of unpredictability in the selection of further audit procedures
to be performed;
(v) Making general changes to the timing, or extent of audit procedures as an overall response.
E.g performing substantive procedures at period end instead of at an interim date.
Considering the nature, timing and extent of further audit procedures

Nature

The nature of further audit procedures relate to their purpose (tests of controls or substantive
procedures) and their type which may be:

(i) Inspection;
(ii) Observation;
(iii) Inquiry;
(iv) Confirmation;
(v) Recalculation;
(vi) Re-performance;
(vii) Analytical procedures.
Certain audit procedures may be more appropriate for some assertions than others.

In relation to revenue tests of control may be most responsive to the assessed risk of misstatement of
the completeness assertion. On the other hand, substantive procedure may be most responsive to the
assessed risk of misstatement of the occurrence assertion.

Determine overall responses to assessed risks of misstatement of revenue

.
Completeness Tests of
Revenue: Risk Asse
control
of material rtion
misstatement level

Substantive
Occurrence tests
 Figure7. 2

Selection of audit procedures

This depends on the assessment of risk. The higher the auditor’s assessment of risk, the more reliable
and relevant is the audit evidence sought from substantive procedures. The types of audit procedures to
be performed as well as their combination may be effected such that the auditor may, in the case of
confirmation of the completeness of a contract, seek confirmation from a third party as well as inspect
the relevant documents.

Obtaining information about the accuracy and completeness of information produced by the entity’s
information system

This is required where the information is used in performing audit procedures.

If the auditor uses non-financial information or budget data produced by entity’s information system in
performing audit procedures such as substantive analytical procedures or tests of controls, then the
auditor must obtain audit evidence that such information is not only accurate but complete.

Timing

This refers to when audit procedures are performed or the period or date to which the audit evidence
relates.

Tests of control or substantive procedures may be performed at an interim or end of the period. Where
the risk of material misstatement is higher, it may be more beneficial to perform substantive procedures
at the end of the period rather than an earlier date. Furthermore, the following steps may be taken:

(i) Perform audit procedures unannounced or at unpredictable times like at selected locations
unannounced;
(ii) Resolution of significant matters identified during interim audit with management or
developing an appropriate audit procedures to resolve them;
(iii) If tests of control were performed prior to period end, additional evidence required for the
remaining part of the period should be considered;
(iv) Performing some critical audit procedures only at or after the period. This may include:
- agreeing the financial statements to the accounting records;
- examining adjustments made during the course of the preparation of the financial
statements.
When transactions are individually material or an error in cut-off may lead to to material
misstatement, transactions may be inspected near the period end.

Factors to consider on when to perform audit procedures may include:

(i) The control environment;
 (ii) When relevant information is available. This may relate to cases where electronic
files are overwritten or when procedures to be observed are performed at certain
times only.
(iii) The nature of the risk.
In cases of inflated revenue for example, contracts available on the date of the
period end may be examined.
(iv) The period or date to which the audit evidence relates.
Extent

This includes the quantum of a specific audit procedure to be performed. It may relate to a sample size
or the number of observations of a control activity. It is usually determined by the judgment of the
auditor after considering the:

(i) materiality;
(ii) assessed risk ;
(iii) degree of assurance desired i.e. planned to obtain.
The auditor will normally increase the extent of audit procedures as the risk of material misstatement
increases. Nonetheless, the audit procedure itself must be relevant to the specific audit, otherwise,
increasing the extent of the audit procedure may be meaningless. It follows, therefore, that it is the
nature of the audit procedure that is of most important consideration.

Elements of Audit Procedure

Nature
Timing Extent:
-purpose &
Sample size,
type
number of
observations

What
nature?

Purpose: Type:
Tests of inspection,
control & sub inquiry etc
procedures

Figure 7.2
7.2 The significance of organizational charts and flow charts in an audit procedure
for work control, in-depth graphing and sampling techniques
7.2.0 The significance of organizational charts in an audit procedure

An organizational chart is a diagram which conveys the internal structure of an entity visually by
detailing the roles, responsibilities, and relationships between individuals and groups within the
entity.

It is a diagram showing graphically the relation of one official to another in a company and It is
used as well to depict the relation of one department to another. Such charts are valuable in that
they enable visualization of a complete organization in diagrams. Organizational charts also
show groups and sub-groups forming an organization.
It follow, therefore, that organizational charts provide an auditor with pictorial of individuals and groups
or sub-groups within a client’s organization. A typical organizational chart may be represented as
follows:

Company Qewest Plc

Board of Directors

Managing Director

Finance
Marketing Director
Director
Production Director

Fin. Marketing
Mgt Acct Controller
Acct Production Controller

Figure7.4: An Organizational Chart

7.2.1.1 The significance of organizational charts in an audit procedure for Work control

Organizational charts show clearly, interrelationship between employees in an organization as well as

hierarchy within the structure. This enables the auditor to establish line of command within the
organization of a client and to design appropriate audit programmes for the engagement.

Organizational charts also show the extent of segregation of duties. When such is reviewed and assessed
by the auditor, the outcome enables him to evaluate the effectiveness of the internal check and by
implication, the possibility of misstatement by an officer going undetected by another officer. Where the
organizational chart is assessed as ineffective or inappropriate for the organization, the auditor may
need to execute substantive procedures and more elaborate in – depth analysis.

7.2.1.2 The significance of organizational charts in an audit procedure for In-depth graphing

In-depth graphing is an analytical tool used by auditors to evaluate audit evidence obtained in the
course of field work. Where errors and other misstatement of financial data is rampart in an
organization, the auditor may deploy in-depth graphing as an analytical procedure. Let us assume that
while vouching cash sales for the 2019 audit year, the auditor detected that in 6,000 vouchers he
attested, 4,800 or 80% were rejected, spreading through the twelve months all departments. The
question then may be why was error so pervasive? Which month has the highest frequency of errors
and which has the highest in value? Graphical presentation of the data will provide detailed answers to
the questions thus allowing the auditor to respond adequately to the areas of significant assessed risk.
In so doing sampling techniques may be utilized.

Furthermore, in the performance of in[depth analytical skill, the organizational chart which would have
been assessed by the auditor would enable him to take timely decision on members of staff to relate
with either within the management or those charged with governance in his response to the assessed
risk of material misstatements.

7.2.1.3 The significance of organizational charts in an audit procedure for sampling techniques.

In most cases, organizational charts are hierarchical. This assists in application of sampling techniques by
an auditor. In our hypothetical case of 80% identified errors and misstatement of financial information
in a reporting year spread among the departments and months, the auditor for want of time and other
reasons may not be able to investigate the 4,800 voucher 100%. He may therefore need to test selected
months and a sample of the officers across the organizational hierarchy. The basis of such stratified
sampling will be the organizational chart. Thereafter, communication with members of the organization
for further audit procedures or interview or physical examination of items may also be on a sample
derived from the organogram.
7.2.2.0 The significance of flow charts in an audit procedure for work control, in-depth graphing and
sampling techniques

Flowcharts are a type of diagram representing an algorithm, workflow or process. They show the
steps as boxes of various kinds, and by connecting them with arrows, show their order.
Therefore, they are often used in auditors’ procedures to visualize systems involved in an
organization.

Flowcharts are easier and less time consuming for others to understand compared to a
narrative or other means of documentation or analysis. By placing everything in a visual
manner, flowcharts make it easier for an auditor to identify redundancies within an
organization's system of internal control.

Compared to other means of documentation, flowcharts identify areas of control implicit in a

system thus making it a superior analytical tool.

Consequently, flowcharts –basic or detailed- are significant in an audit procedure for work control, in-
depth graphing and sampling techniques

An example of a flowchart depicting audit pre-planning is illustrated below:

Figure 7.5

7.2.2.1 The significance of flow charts in an audit procedure for work control

Work control relates mainly to the quality of audit performance. This is the focus of the Nigerian
Standard on Auditing (NSA) 3. It deals with:
 (i) the specific responsibilities of the auditor regarding quality control procedures for an audit of
financial statements.
(ii) the responsibilities of the engagement quality control reviewer where necessary
The NSA is to be read in conjunction with the Professional Code of Conduct and Guide for Members of
the Institute of Chartered Accountants of Nigeria (ICAN Code).

According to the NSA 3, the objective of the auditor is to implement quality control procedures at the
engagement level which provide the auditor with reasonable assurance that:
(a) The audit complies with professional standards and applicable legal and regulatory requirements; and
(b) The auditor’s report issued is appropriate in the circumstances.

The significance of flowcharts in an audit procedure for work control therefore, is to assist the auditor in
assessing audit risks regarding:
(i) compliance with professional standards;
(ii) compliance with applicable statutory and regulatory framework;
(iii) appropriateness of the auditor’s report in the circumstance.

For example, assessing the extent of compliance with statutory and regulatory framework an overview
flowchart could be:

Start

Document Document
reasons for Full compliance with
No CAMA (1990)?
Yes
non-
compliance

Figure 7.4: A Simple Flowchart on Work

Control

7.2.2.2 The significance of flow charts in an audit procedure for in-depth graphing

In-depth graphing deals more with analytical procedure. The significance of flowcharts in this regards is
to ensure that appropriate analytical tools such as comparison, ratio analysis or trend analysis are
carried where necessary. The flow charts will show the sequence of the tests as well as audit programs
executed for each test. Compliance with NSA 18 on analytical procedures is essential in this case.
7.2.2.3 The significance of flow charts in an audit procedure for sampling techniques

Audit sampling, according to NSA 19, is ‘The application of audit procedures to less than 100% of items
within a population of audit relevance such that all sampling units have a chance of selection in order to
provide the auditor with a reasonable basis on which to draw conclusions about the entire population’

NSA 19 further states that the objective of the auditor, when using audit sampling, is to provide a
reasonable basis for drawing conclusions about the population from which he selects his sample.
The significance of flow charts in this procedure is to ensure that samples are selected within a
reasonable and identifiable process. If stratified sampling technique is used for example, flowcharts will
show the strata and how samples are selected from each stratum.

7.3 Testing of the system of internal control, compliance tests, transaction tests and functional test

7.3 .1 Testing of the system of internal control

A test of controls is an audit procedure to test the effectiveness of controls used by a client
entity to prevent or detect material misstatements. Depending on the results of this test, an
auditor may choose to rely upon a client's system of controls as part of his auditing activities.
However, if the test reveals that controls are weak, the auditors will enhance their use of
substantive testing, which usually increases the cost of an audit. The following are general
classifications of tests of controls:

 Reperformance. Auditors may initiate a new transaction, to see which controls are used
by the client and the effectiveness of those controls.

 Observation. Auditors may observe a business process in action and in particular the
control elements of the process.

 Inspection. Auditors may examine business documents for approval signatures, stamps,
or review check marks, which indicate that controls have been performed.

If the inspection approach is used, a test of controls is typically conducted for a sample of
documents related to transactions that occurred throughout the year. Doing so provides evidence
that the system of controls has operated in a reliable manner throughout the reporting period.
A test of controls is made irrespective of the value of the underlying business transaction. The
main point of the test is to see if a control functions properly, so the value of a transaction is not
of consequence to the goal of the test.

If the auditor encounters an error in a test of controls, the sample size is expanded and further
testing may be conducted. If additional errors are found, they will consider whether they result
from a systematic controls problem that render the controls ineffective, or if the errors appear to
be isolated instances that do not reflect upon the overall effectiveness of the control in question.

Tests of controls
September 16, 2019
Steven Bragg

https://www.accountingtools.com/articles/what-are-tests-of-controls.html#:~:text=A%20test%20of
%20controls%20is,prevent%20or%20detect%20material%20misstatements.&text=Auditors%20may
%20observe%20a%20business,control%20elements%20of%20the%20process.

Retrieved on June 5, 2020

7.3.2 Testing of the system of compliance tests

“Compliance testing” also known as Conformance testing is a nonfunctional testing

technique which used to validate the extent to which system developed meets the
standards prescribed by the organization. It is performed to assess if all the specified
standards are met or not. The need for compliance test includes:
 Determining that the development and maintenance process meets the
prescribed methodology.
 Ensuring that the deliverables of each segment of the entity meets the standards,
procedures, statutory laws and guidelines.
 Evaluating documentation disclosures to validate completeness and
reasonableness

How to do a compliance check

Compliance test is usually by inspection and may be conducted as follows:
 (i) Sets of standards, procedures, ethical codes, financial reporting framework of
the entity are verified;
(ii) Deliverables of each set are compared against the standards and deficiencies
identified;
(iii) Areas of non-compliance should be identified;
(iv) Findings should be documented and communicated to management or those
charged with governance.
https://www.softwaretestinghelp.com/what-is-conformance-testing/

Retrieved on June 5, 2020

7.3.3 Testing of the system of transaction tests

Transaction testing is done to ensure the complete integrity and success of business

transactions. Transaction tests assist to provide assurance that controls are not

compromised. Transaction tests include:

 Quality transaction testing: Following activities are covered under quality

transaction testing:

1. EDI Mapping: EDI or Electronic data interchange which facilitates

electronic transmission of data requires the information converted in

electronic form to be mapped. Quality testing ensures that the

whereabouts of information in electronic form are well tracked by

verifying the process for EDI mapping.

2. Quality transaction testing helps remove ambiguities in data content

pertaining to monetary exchanges.

3. Validation of data dictionaries: Every database management system

requires the use of a data dictionary to lucidly organise all the data files

and the relations between them with details of their name, and purpose in
 the form of a central repository. The entries in this dictionary require to be

tested for authenticity and verification

4. Optimum application of code sets: Organization’s the world over,

require a set of prescribed procedures and rules which govern the working

of transactions in online mode. Quality testing sees to it, that the

exchanges taking place via computing follow the code sets with as much

compliance as is possible.

5. Transition to new releases: Quality transaction testing checks that the

transactions do not suffer in quality with the release of new upgrades and

standards of efficiency are well maintained

6. Quality transaction testing assures efficient standards for transmission of

data.

 Quantity transaction testing: Quantity transaction testing looks into

Capacity to process enlarged quantity

This addresses questions such as:

Future aspirations of the entity

Every organization, be it from the e-commerce domain or the banking company plans

for changes to metamorphose on to a larger scale for expansion. This requires the

transaction system used by the company to adapt as per the expected. This requires the

new transaction system capacity to be verified for working with greater number of

customer orders and greater amount of finances to be validated.

 Business transaction testing: This facet of transaction testing concerns itself

to doubly ensure that all the needs of the industry are being met with the product

specializing in running transactions. The transactions are not always of the same

nature. They may be:

1. Simple transactions: Those which are one time occurrences or happen

only once.

2. Complex transactions: those which require a series of different events

before completion.

3. Ongoing transactions: Those which involve vendor contracts Other

than these there are transactions which consists of end to end loops or

those which are executed on different processors but centrally connected

to a singular main computer.

4. All these different variants of transactions are required to be tested .

 Compliance certification: Other than the 3 main forms of testing, every

transaction based system requires to pass through levels of compliance namely:

o Balancing tests (for transaction counts and checking of financial balances)

o Requirement testing(for repeat counts)

o Situation testing

o Integrity testing(for checking of validity of segments)

https://www.professionalqa.com/transaction-testing

Retrieved on June 5, 2020

Another dimension to test of transaction is presented below:

TESTS OF TRANSACTIONS AND TESTS OF BALANCES

The auditor's tests of the accuracy of monetary amounts of

transactions and account balances are known as substantive testing.
Substantive testing is very different from testing controls.

Substantive tests verify whether information is correct, whereas

control tests determine whether the information is managed under a
system that promotes correctness. Some level of substantive testing
is required regardless of the results of control testing. If weak internal
controls exist or if important controls are not in place, extensive
substantive testing will be required. On the other hand, if controls are
found to be effective, the amount of substantive testing required is
significantly lower, because there is less chance of error in the
underlying records. Exhibit 7-9 presents a process map of the
substantive testing phase of the audit.

In an IT environment, the evidence needed to determine the

correctness of transactions and account balances is contained in
electronic data files within the computer system, from where it may be
pulled by specialized audit techniques. Some techniques used to test
controls can also be used to test transactions and financial statement
balances. For example, parallel simulations, the test data method, the
embedded audit module, and the integrated test facility can be used
for both control testing and substantive testing.

Recent trends such as advances in automated controls; new

compliance requirements;
https://www.oreilly.com/library/view/accounting-information-systems/9781118162309/c07-
17.html

Retrieved on June 5, 2020

7.3.4 The testing of the system of functional test

Functional testing is a type of testing the system against the functional

requirements/specifications.

Functions (or features) are tested by feeding them input and examining the output.
Functional testing ensures that the requirements are properly satisfied by the
application. This type of testing is not concerned with how processing occurs, but rather,
with the results of processing. It simulates actual system usage but does not make any
system structure assumptions. It is a form of testing which verifies that the software
performs its stated functions as expected by the users.

During functional testing, Black Box Testing technique is used in which the internal logic
of the system being tested is not known to the tester.

Functional testing is normally performed during the levels of System

Testing and Acceptance Testing.

Typically, functional testing involves the following steps:

1. Identify function that is to be performed.

2. Create input data based on the specifications of function.
3. Determine the output based on the specifications of function.
4. Execute the test case.
5. Compare the actual and expected output.

Functional testing is more effective when the test conditions are created directly from
user/business requirements. When test conditions are created from the system
documentation (system requirements/ design documents), the defects in that
documentation will not be detected through testing and this may be the cause of end-
users’ wrath when they finally use the software.
http://softwaretestingfundamentals.com/functional-testing/#:~:text=FUNCTIONAL%20TESTING
%20is%20a%20type,properly%20satisfied%20by%20the%20application.

Retrieved on June 5, 2020

QUIZZES

1. The focus of work control in audit is …………of financial statements.

2. In-depth analysis benefit from analytical procedures such as ratios analysis, graphical
analysis and…………
3. The essence of sampling to make representative selection of items from a given……….
4. NSA 9 on planning deals more with timing, nature and …………..of procedures.
5. Methods of effecting audit tests include observation, ……………and re-calculation.

REVISION QUESTIONS

1. Briefly explain the essence of sampling in in-depth analysis.

2. (a) What is functional test in auditing?
(b) Enumerate steps involved in functional testing;
(c) State one accounting function known to you. As an auditor, sketch how you would
test the function.
3. NSA 10 deals with the auditor’s understanding of the entity, its environment and the
internal control system. Discuss the essence of this standard on the audit of Lagos City
Polytechnic for the year ended December 31, 2019.
4. (i) Draw a simple flowchart to reveal the relationship between test of controls,
substantive test and test of transactions.
(ii) Justify the need for vouching in test of control.

5. Write briefly on the significance of NSAs 2 and 3 on work control areas.

ASSIGNMENTS
1. (a) Tabulate existing International Standards on Auditing (NSAs) and the corresponding
local equivalents.
(b) Briefly distinguish between NSA 4 and NSA 19 in relation to test of compliance.

2. (a) Differentiate between substantive test and transactional test.

(b) You are the external auditor of Afoke Ltd. For the year ended March 31, 2020,
financial audit is to commence on July 1, 2020. Draw an overview flowchart of your
planned study of the entity, its environment and its array of internal control systems.