Audit of financial statements.

• Auditors support their opinion based on evidence collected from assertions.

• What is key here is to understand the auditor’s objection and the procedure to achieve such an objective

• Assertions are auditors’ representations on financial statements. They include (without classification) the
following;
1. Occurrence – the transactions and events that have been recorded or disclosed have occurred, and such
transactions and events pertain to the entity
2. Completeness – all transactions and events that should have been recorded have been recorded, and all
related disclosures that should have been included in the financial statements have been included
3. Accuracy – amounts and other data relating to recorded transactions and events have been recorded
appropriately, and related disclosures have been appropriately measured and described.
4. Existence – assets, liabilities, and equity interests exist.
5. Rights and obligations – the entity holds or controls the rights to assets, and liabilities are the obligations
of the entity.
6. Presentation and disclosure assets, liabilities and equity interests are appropriately aggregated or
disaggregated and clearly described, and related disclosures are relevant and understandable in the
context of the requirements of the applicable financial reporting framework
7. Measurement – transactions or events are recorded at the proper amounts and revenues and expenses
are allocated to the proper period
8. Cut–off – transactions and events have been recorded in the correct accounting period.
9. Classification – transactions and events have been recorded in the proper accounts.
LECTURE TWO
 INTERNAL AUDIT AND OTHER THIRD PARTIES
• The internal audit function is an appraisal or monitoring activity
established by management and directors for the review of internal control
as a service to the entity.
• The code of corporate governance requires directors to review the need
for internal audit.
• In to achieve an element of independence from the executive, we expect
internal audit to report to the audit committee.
• The main functions of the internal audit department is to examine,
evaluate, and report to management and directors on the adequacy and
effectiveness of internal controls.
• They play a significant part in designing internal control systems report on
departures from that system and suggest where it can be improved.
 Scope! Objectives / Functions of internal
Audit
• Helps in the achievement of corporate objective
• Aids risk assessment and management
• Improves efficiency effectiveness and economy
• Designs internal control systems
• Checks operation of internal systems
• value for money audit
• Test for IT controls
• Liases with external auditors or some times share work.
 Can External Auditors Rely On The Work Of
Internal Auditors?
• Will consider the following;
• Independence of the internal audit
• Organizational status of the internal audit department.
• Scope & objectives
• Standard of professional care.
• Technical competence of the internal audit staff
• Reporting standards
• Resources available
Can External Auditors Rely On The Work Of
Internal Auditors? Cont …
• Using work done by internal audits one example of whether auditors rely on the works of 3rd parties. Other
examples are
• Estate agents
• Lawyers
• Valuers
• Actuaries etc
• The auditors should ensure that the 3rd parties are;
• Qualified
• Experienced
• Independent
• Professional
• The auditors should be willing to challenge experts’ opinions (professional ) or seek for second opinion from
another expert.
• Auditors and 3rd parties should agree on the following in writing
• Nature, scope and objective of work
• Respective responsibilities
• Nature scope and ti ing of communication
• That the expert observes confidentiality
 Audit failures
• A situation in which an audit wrongly states that a company’s accounts are
correct when they contain mistakes or false statements
• The causes of audit failure:
• Failure by the auditor to use appropriate audit samples that are
representative of the population of transaction
• Auditor’s gross errors at any stage in the audit. For example by
misapplying, misinterpreting GAAP or IASs or personal negligence.
• Lack of independence
• Incompetence
• Inadequate review of financial statements by the auditor at the audit
finalization stage.
The Chronology of Audit / Stages of the Audit
Plan the audit

Understand the entity

Assess risk of material misstatements
Respond to risk

Expect effective controls Expect ineffective controls

Unsatisfactory
Test of controls Report significant deficiencies to
those charged with governance to
Satisfactory Mgt and weaknesses to Mgt

Restricted substantive tests Overall review of F/S Full substantive tests

Report to management

Auditors report
Audit planning: Objectives
• To identify and give appropriate attention to important areas ;
significance of different transactions
• To identify potential problems eg change accounting systems
• To carry out work expeditiously and efficiently
• To make sure the right number of staff are present with the right
skills.
• To coordinate if necessary with other parties
Audit planning: importance
• Planning is effectiveness
• Helps in determining the strategy and a detailed approach
Understanding the entity
• Just like planning, at this stage you are gaining an understanding of the
entity, it involves;
• Nature of the entity (manufacturing, wholesale, retail, financial sector etc
• Different regulations
• Accounting policies the entity employs. Eg inventory valuation,
depreciation,
• Nature of business risks.
• The internal controls,
• The control environment
• Financial performance
 ERRORS AND FRAUDS
• An error is an unintentional mistake in financial information
• A fraud is an intentional misrepresentation of financial information by
one or more individuals among the management or employees.
ERRORS FRAUDS

They are not intentional They are intentional

They are easy to detect Difficult to detect

Committed by lower level staff Committed by high ranking officer

Indicators of the Presence of Frauds
• Where Mgt is by one person or a small group of people.
• Where there is high turnover of key accounting personnel,
• The evasive or unreasonable response of management to audit
questions may be due to cover up frauds
• Transactions between related parties whether they are related
• inadequate working capital to support the company’s capital
requirement e.g. cash
Detection of Frauds
• Mgt for prevention and detection of frauds and error through
designing strong internal controls
• The Board of directors, internal audit function should help minimize
likelihood of fraud and report to the audit committee of the board.
The external auditor’s responsibilities
• Under statutory audits, the external auditor has no specific responsibility
for the prevention of fraud and error. However, the auditor should assess
the risk and fraud or error may cause the financial statements to contain
material misstatements and design appropriate audit tests.
• The auditor should accept the evidence he gets during the audit unless
they are suspicious circumstances. However, he should conduct his work
with an attitude of professional skepticism
• An auditor should design audit procedures to obtain reasonable assurance
that material fraud and error have not occurred, or that if they have either
been corrected or properly disclosed in the financial statements
Auditor’s liability to fraud
• The auditor is probably liable if he fails to detect material fraud and error.
He may be exonerated if the fraud is difficult to detect. An auditor may not
be held negligent for not detecting immaterial fraud or error.
• He may be held negligent in case of immaterial fraud and error where;
• He carries out audit procedures on immaterial items and these procedures are
carried out satisfactorily and consequently fail to detect the immaterial fraud.
• He finds immaterial fraud while carrying out his normal procedures and does not
report it to the company’s management
• He carries out audit procedures on immaterial items at the specific request of the
company’s management, and then he fails to detect the immaterial fraud due to
negligent work