Audit theory notes 2016

Topic 1INTRODUCTION 1.1.0 Background Early Auditing (Vouching Audits) Auditing began as a vouching process and developed from the word audire, which means to hear. In early Audits, an auditor was supposed to conduct vouching audit, which implied checking all transactions so as to detect errors and frauds, which as of then was the main objective of an audit. Under this process the auditor was supposed to prove the true and correct view of company’s financial affairs, which necessitated checking all the transactions, it was possible because transactions were few and could be audited in one single session. Modern Auditing (system based audits)These audits were introduced mainly after 1948. Under these audits, the auditors are expected to rely on the presence and strength of internal control system of the organization. In this case the auditor will apply tests on a sample of entries drawn from population of entries and results of the sample are taken to represent those of the entire population. Such audits were necessitated by the fact that transactions of many organizations increased, making it difficult for an auditor to check for all of them in one session thus the need for sampling. This also meant that the auditor would no longer prove the true and correct view but rather the true and fair view of company’s financial state of affairs.1.2.0 Definition of AuditingAuditing is an independent examination of books of accounts and underlying documents of an enterprise by a qualified auditor so as to ascertain: -

Whether the enterprise has kept proper books of accounts as per requirements of the Company Act

Whether financial statements agree with contents of accounts and Whether such statements portray the true and fair view of company’s state of

affairs as at a given date. Key issues in the above definitions 1. IndependenceAn auditor is an independent person and he should portray an independent attitude during his/her examinations so as to achieve objective reporting.It benefits the owners i.e. shareholders and third parties e.g. government, donors, creditors etc. in that it helps the auditor to form an unbiased opinion hence credible financial statements. The profession for that reason has given auditors guidelines to ensure that such independence is observed both during the practice and outside the practice. For this reason an auditor should not:

a. Give loans to or get from 3rd parties or owners who will use his opinions. b. He shouldn’t have blood relations with parties who will use his report. c. He shouldn’t have any interest in the clients company in form of shares,

etc. 2. Opinion The end product for auditors’ examination is an expression of an opinion by the auditor. The auditors’ opinion might be negative, technically known as a qualified opinion or it may be positive, technically known as unqualified opinion. 3. Financial Statements

BBA/DBA -2 – Audit Theory-Lecture Notes by ALLEN NUWAMANYA Page 1

These include balance sheet, Profit and loss account, cash flow statements, etc. These are statements on which the auditor has to form an opinion as to whether they show a true and fair view of the company’s state of affairs. 4. Underlying documents These are documentary evidence in support of transactions in the books of accounts e.g. receipts. From vouchers, the auditors try to ascertain whether;

The transactions are for the current financial period.( cut off test) They are for the particular company in question (Client Company). They are properly authorized. Properly recorded according to generally accepted accounting principles GAAP.

5. True and Fair View True and fair view implies that the company’s financial statements, assets or liabilities profit or loss reflects the exact picture of the company’s financial performance. Objectives of an Audit These are categorized into three;

i. Statutory objectives ii. Professional bodies requirements

iii. Incidental objectives iv. Corporate governance objective

\1. Statutory Objectives i). To prove the true and fair view or otherwise, of the company’s financial state of affairs. This implies that an auditor must certify the company’s financial position at the end of the audit as to whether financial statements portray a true and fair view.ii). The auditor is supposed to ascertain whether the company has kept proper books of accounts which should be in agreement with the financial statements e.g. cashbook, ledgers, Journals, Asset registers, etc.iii). The company Act requires the auditor write a report at the end of his/her audit in which he should communicate his findings out of his examination. 2. Professional Bodies RequirementsThese require the auditor to give advice to the company in the letter of weaknesses or management letter in which the auditor endeavors to highlight problems in the internal control systems; budgetary controls etc. 3. Incidental Objectives An auditor has to detect material errors and frauds so that affect the true and fair view of the company’s state of affairs. However this duty is the role of the company’s management and thus incidental to the auditor. 4. Corporate governance objective There have been an increasing number of companies failing as a result of mismanagement. There is therefore a new call for auditors to report on how companies are managed, controlled and directed by those charged with their governance in any statutory audit. 1.4.0 The Auditors Rights and Duties The auditor has various detailed duties to perform in order to achieve the overall duty to report a True and Fair view of the company’s state of affairs. In order to fulfill these duties various legal rights are given to the auditor. Duties of an Auditor (S. 162)

1. To report on the financial statements to form an opinion as to:-


o Whether they have obtained all information and explanations necessary for the audit.

o Whether in their opinion, proper books and returns have been kept. o Whether the balance sheet and profit and loss account are in agreement

with the books of accounts of accounts and returns. o Whether the accounts have been prepared in accordance with the Act or

firms constitution. o Whether the director's report is consistent with the accounts. o Whether the financial statements show a true and fair view. 2. To qualify the report if the above in (1) are not satisfied. 3. To consider whether the information in the management report

(management representation) is consistent with the financial statements. 4. To include additional information in the report connected with the director's

remuneration and loan to officers, in case it is not provided in the accounts. Rights of an Auditor (S. 162)The rights given to the auditor under national legislation are designed to ensure that he is able to fulfill his duties and responsibilities to the members. These include:-

1. Access to records, books of accounts, and documents at all times. Never use force or seek court redress when refused access. Simply resign or qualify the report.

2. To get information and explanations from officers necessary for the audit. 3. To attend or get notices of meetings like any shareholder. 4. To speak at the General Meetings as an auditor. 5. To get information from branches or subsidiaries. 6. To get written resolutions proposed. 7. To remuneration if he has completed his work. 8. To sign the audit report. 9. During removal - make representations to shareholders, attend and speak at the

meeting where he is being removal etc. 1.5.0 Parties Who Benefit From Audited Accounts 1. Creditors/Suppliers These use audited accounts to ascertain the company’s ability to meet their short-term obligations as and when they fall due. Also if these are long term suppliers they will use audited accounts to assess the company’s long-term liability. 2. Customers/Debtors These are interested in company’s long term survival to ascertain whether the company can fulfill their long term interests e.g. depositors <->bank. 3. Bankers These use audited accounts to ascertain whether the company can settle their short-term obligations such as bank over drafts and short-term loans, and long-term obligations such long-term loans. 4. Government The government is interested in audited accounts to ascertain tax liability public goods. 5. Competitors These are interested in company’s profitability and market share and how they can compete favorably for the markets. 6. Share holders/investors


These use audited accounts to check the capability of the organization in paying their dividends fully and on time. 1.6.0 Advantages of Audit

1. An audit gives assurance and credibility to the accounts for the benefit of potential investors. The investors utilize audited accounts to ascertain company’s performance.

2. Audited accounts are used to detect errors and frauds, which could otherwise lead to the failure of the organization.

3. Auditing of accounts enables accounting staff to keep their accounts to date and acts as a source of management information upon which decisions will be made.

4. Audited accounts are used by organizations to raise funds from different financial institutions.

5. Audited accounts are used by income tax authorities to assess or ascertain company’s liability and as such avoids any possible disputes between the company and income tax department/authorities.

6. In case of sale of business, a merger businesses acquisition or take over of business, audited accounts are useful as they indicate the fair value of assets to be acquired.

7. In case of partnerships the audited accounts are used; a). As a basis of sharing profits and thereby minimising disputes between partners.b). As a basis of distributing assets and liabilities amongst partners in the case of dissolution of partnership business.

Disadvantages of an Audit 1. It is usually a very expensive exercise because audit fees and audit

expenses is always too high especially for small companies. 2. If the result of the audit is bad (qualified), this can lead to the failure of the

business. 3. An audit may not be ideal for small business whose transactions are too

few. 4. An audit may not in most cases be in the interest of the owners especially

when these are managers in which case they end up frustrating the entire process etc.

5. Expectation gap- people always believe that the auditors work is detect errors and fraud.

1.7.0 Qualities of an Auditor 1. He should be a master of all fields of Accounting such as Financial

Accounting Cost Accounting, Management Accounting, Income Tax, etc. 2. He must be Honest - a person of unquestionable integrity 3. He must be able to ask intelligent questions in order to extract audit

evidence. 4. He must be independent i.e. he must not have interests in the firm he is

auditing. 5. He should grasp quickly the features of the organisation, e.g.

organisational structure, product line, size of the business etc. 6. He must be tactful so as to gather audited evidence according to his

opinion. 7. He should not reveal the secrets of his clients.


8. The person should be accurate, vigilant and cautious during his course of audit work.

9. He must be able to document his opinion in an audit report .Ability to write a good report, which is concise and clear is a requirement.

1.8.0 Differences between Auditing and Investigation1. Auditing is carried out by Certified Public Accountants where as

investigation carried out by competent accountants. 2. Auditing is the examination of books of accounts to prove the true and fair

view where as an investigation is searching inquiry into the affairs of the organisation.

3. Auditing covers only one financial period where as investigations could cover more than one financial period.

4. Auditing is guided by professional ethics and guidelines where as investigations are not guided by any standard guidelines.

5. Auditing is conducted for stakeholders where as investigations are conducted for the owners of the organisation (investigation is conducted for particular people and for particular purpose while Auditing is done generally and carried for benefits of all stake holders).

1.9.0 Differences between Auditing and Accounting1. Auditing is an examination to firm’s financial statements with the view of

expressing true and fair view of the statements. On the other hand, accounting is simply the preparation of the books of accounts in order to aid the management in their decision making process.

2. Auditing is usually conducted at the end of the financial year while accounting is conducted through out the year i.e. it is a continuous process.

3. Auditing is guided by auditing standards and guidelines (ISAs) and supervised by professional bodies (ACCA). As for accounting, it is guided by accounting standards (IASs or IFRSs) and guidelines and supervised by management.

4. Auditing is performed by a qualified accountant where as accounting is conducted by any competent accountant.

5. Auditing is conducted not only for the owners but also other stake holders where as accounting is concluded by management.

6. Auditing is conducted using tests as an aid to the process of auditing where as accounting is conducted using vouchers, various books of accounts e.g. Journals, ledgers etc.

7. Auditing is based on accounting information which implies that accounting has to be done first and auditing follows.

1.10.0 ERRORS AND FRAUDS ISA 240 Frauds and errors states that: An error is an unintentional mistake in financial information such as:-

i. A mathematical or clerical mistake in underlying records or accounting data.

ii. Incorrect, misreporting of figures e.g. transposition of figures. iii. Posting figures wrongly which may include errors of commission or

omission?


iv. Misapplication of accounting policies. A fraud is an intentional misrepresentation of financial information by one or more individuals among the management or employees. It may involve:-

i. Manipulation, falsification or alteration of records and documents. ii. Misappropriation of assets usually for personal use e.g. cash.

iii. Misapplication of accounting policies. Differences between Errors and Frauds

ERRORS FRAUDSi. They are not

intentional. ii. They are intentional.

ii They are easier to detect. ii. They are difficult to detect since most of the information is destroyed.

iii. They are committed by lower level staff.

iii. They are committed by knowledgeable persons, in most cases management.

Instances that Indicate the Presence of Frauds 1. Where a company is managed by one person or a small group of

people. Frauds in this case, exist due to collusion or misuse of power.

2. Where there is high turnover of key accounting personnel, this will lead to fraud arising out of lack of accountability.

3. Where the company’s business is collapsing and failures of business are increasing, this may be due to frauds arising from misuse of company’s assets.

4. The evasive or unreasonable response of management to audit questions may be due to cover up of fraud.

5. Transactions between related parties whether they are related by blood, financial relations or by associations. These collude to cover up frauds.

6. Where there is inadequate working capital to support the companies capital requirement e.g. cash.

Detection of FraudsIt’s not the duty of the auditor to detect frauds as per ISA (International Standards of Auditing) It is the duty of management which must institute a strong internal control system. However auditors must be aware of the risks of frauds if they are to prove true and fair view of company’s financial statements. Therefore the detection of frauds is an incidental duty of auditors. This may be done by the use of following; 1). Analytical reviews These are reviews, which involve the computation of key ratios, percentages, average and investigation of any unfavourable variances or differences.

2). Surprise checks The auditor may use surprise checks on items such as petty cash, stock etc.

3). Third party confirmation (Circularisation)


This is where circulars are given to creditors and debtors to fill. The replies from these parties are then compared to company’s own record and the differences investigated.

4). Searching inquiry This is an investigation carried out in areas suspected to have frauds e.g. cash, wages payments etc.

5). In depth Auditing (vouching)This is an initial examination of selected transactions, which are checked from initial stages to final stages.Prevention of Frauds This can be done through the following ways:

1. Through routine checking and balancing of accounts. 2. Institute strong division (Segregation) of duties in preparation and

interpretation of accounting information. 3. To give reasonable salaries and benefits to employees according to their

qualification experience and sensitivity of their jobs. 4. Employment of qualified staff to handle technical areas or sensitive area

of an organisation. 5. Institute periodical comparisons of the budgeted and actual situations. 6. To use where possible computerized accounting systems so as have

accounts that are computerised. 7. Clear job descriptions which involves allocation of jobs and functions

such that personnel responsibility is clearly defined.

Detection of Errors

This can be done through the following ways: 1. Use of comparative figures e.g. current years figures against previous

figures and investigation carried out, in case of unfavourable variances. 2. The auditor should trace the names of accounts from various ledgers to the

Trial balance and ensure that no account was left out in the positing process.

3. He should count accounts or items in the current trial balance and compare them with those of previous year’s trial balance and then investigate the differences.

4. The auditor should check the total of balances and find out if there are any differences.

Prevention of Errors Errors may be prevented as follows:

1. The organization or the company should employ qualified staff within the technical field.

2. Use of mechanized accounting systems. 3. Use of closer supervision of staff over managing sensitive jobs. 4. Use of surprise checks of items subject to errors such as cash and ledger accounts. 5. Use of automatic transfers or rotation of duties in order to cut continuity of errors

perpetrated.


TOPIC 22.0.0 TYPES OF AUDITSAudits can be classified in two ways, i.e.

a. According to the nature of work done. b. According to the approach to the work to be done.

2.1 0 According to the nature of work done.By this classification, the nature of work may be statutory or private, hence resulting to statutory audit or private audit 2.1.1 Statutory AuditThese are audits that are conducted as per the requirements of the Company Act and hence they are mandatory. This type of audit is carried out for limited companies. I.e. public or private ltd. It is conducted by an auditor appointed as per the Company Act.The objective of such an audit is to prove the true and fair view of the organization. Statutory audits are done at the end of a financial year and the report produced is addressed to the shareholders.In this case, the duties and rights of an auditor are defined by the Company Act. The auditor performs pure audit work. 2.1.2 Private AuditThese are audits that are carried out as per the wishes of the directors or owners of the business hence they are not mandatory. Private audits are carried out for organisations such as partnerships, clubs, NGOs, sole traders etc, however; the owner of the business does the appointment of auditors. The objective of such an audit is to detect errors and frauds, and to ascertain profits for tax purposes. These audits can be done anytime during the financial period, and the report produced is addressed to the stakeholder. The owners of the business define the duties and rights. The auditor may perform both auditing and accountancy.Similarities between statutory and private audits

o Both are carried out by Certified Public Accountants. o Both are carried out using auditing guidelines and standards. o In both cases, the auditors may provide management advisory services to

the clients. o In both cases, reports are used as bases for decision-making o In both cases, reports are used by income tax authorities and financiers in

determining performance. o In both cases, the audits will boost the morale of the accounting staff to

keep their accounts up to date. 2.2.0 According to the approach of work to be done. These include: -

a. Continuous audit b. Interim audit c. Procedural audit d. Management audit e. Final audit/complete/detailed

2.2.1 Continuous Audit


These are audits, which involve detailed examination of books of accounts at regular intervals of say three to four months. Such audits are ideal for:-

i. Banking businesses where by virtue of their transactions, the auditor has to conduct continuous audits to detect and prevent errors and frauds at their earliest stages.

ii. Companies whose volume of transactions is large and cannot be audited in one session e.g. manufacturing companies.

iii. Organisations whose internal control systems are weak. iv. Where the statement of accounts is required to be presented to the

management after every three or four months. Advantages of Continuous Audit.

1. Errors and frauds can be detected and prevented at their earliest stages before they have reached advanced proportions.

2. This audit will enable the auditor to have a sound technical knowledge of the business, which will help him in performing efficient audits.

3. This audit may boost the morale of accounting staff, who will keep their accounts up to date, lessen the possibility of committing frauds and hence facilitate the auditors’ work.

4. It enables the auditor to conduct his final audit efficiently because much of the audit work will have been tackled during the continuous audit and less will be left for the final audits.

5. This audit will facilitate the preparation of the management letter, since by virtue of his constant presence in the business he is able to understand it and give advice on the situation pertaining to the company.

Disadvantages of Continuous Audit1. The accounts figures audited may be altered by dishonest clerks in a bid to

perpetrate frauds. 2. It is time consuming and hence a tedious exercise on the part of the auditor. 3. It is an expensive audit because of the time used for a given audit assignment. 4. By virtue of his constant presence in the business, the client’s staff may get used

to the audit staff and this may affect the independence and objectivity of the audit staff leading to a biased opinion.

5. This type of audit will disorganise the clients’ work in so far as books of accounts will be used for audit purposes.

2.2.2 Interim AuditsThese are audits conducted to a particular date within the accounting period e.g. per quarter or half year, and hence form part of the final audit. These audits help to ascertain the company interim performance for the purpose of paying interim dividends. The conditions where these audits are ideal include:-

o Where a company is allowed by its Articles of Association. o Where a company by law is required to publish its interim performance for

the interests of the various parties. Advantages of Interim Audits

1. These audits are useful in the determination of the interim condition of the company. Therefore, the client will know the financial position of the company for the half-year and plan accordingly.

2. It enables the auditor to detect and prevent errors and frauds perpetrated in the interim period (at earlier stages).


3. This audit may boost the morale of accounting staff hence enabling them keep their work up to date, as accounts are checked at regular intervals.

4. It enables the auditor to assess the strengths and weaknesses of an internal control system, which is necessary for the final audit.

5. It entails less disruptions in the clients work as it is conducted mid financial period when the company accounts are mid way prepared.

6. Interim audit help to speed up the completion of final audit at the end of the financial period.

7. This audit is essential for the preparation of interim reports which are necessary for managerial decision making process in areas like:-

o -Raising additional funds for investment purpose. o -Ensuring that a company is operating within the laid down policies, etc

Disadvantages of interim audits1. Dishonest clerks with the intention to commit fraud may alter accounting figures

audited. 2. Errors and frauds detected at this time of the financial period may have reached

advanced stages, hence exposing the organization to serious losses. 3. This audit entails a lot of note taking. In other words, it will mean that the audit

staff will have to prepare notes after the interim audit e.g. interim balance sheet, records of forecasts, budgeted performance figures etc.

2.2.3 Procedural AuditsThese involve the examination and review of a company’s procedures and records so as to ascertain whether these are accurate, genuine and reliable for decision making purposes. These audits are ideal for the following conditions.

i. Businesses operating in dynamic situations and environment such as banks, hotels etc.

ii. Companies whose operations are so technical and need to be updated overtime e.g. motor vehicle industry.

iii. Companies with several procedures, which affect each other such that if one were inefficient, it would disrupt others.

Advantages of Procedural Audits1. This audit may reveal the procedures, which are not working as per laid down

policies and hence may be rectified. 2. This audit will identify procedures, which are not up to date, and this may be

scrapped off or be updated for the benefit of the organisation. 3. It will facilitate the reorganisation of procedures, which will enable the company

to alleviate procedures that lead to duplication of efforts and unnecessary high costs.

4. This audit will reveal procedures which do not have strong controls and these will be strengthened to enable the company to operate efficiently.

5. This audit will reveal procedures, which tend to be bureaucratic and measures then can be taken to rectify the situation. Usually, bureaucratic procedures lead to delay in operations hence inefficiency.

Disadvantages of procedural audits1. This audit is time-consuming and tedious in which case it may frustrate or delay

other audit assignments or engagements. 2. It is an expensive audit to conduct because the auditor will spend a lot of time to

ascertain failure of procedures.


3. This audit may frustrate the top management because the failure of procedures is due to inefficiencies among the top management.

2.2.4 Management AuditThese are audits which involve investigations of the entire management aspects of a business e.g. decision making process, internal control systems, personal relationships with employees etc. The main purpose for this audit is to prepare a report on the effectiveness of the management from the point of view of the profitability and efficient running of the business.Advantages of Management Audits

1. It improves the quality of top management in terms of efficient management of resources, achievement of budgeted goals, effective management of time etc.

2. It reveals the weaknesses in the internal control systems, which is due to management failure to sustain such strong controls. This will also boost managerial supervision and motivation.

3. This audit minimizes bureaucracy in a company hence leading to efficient operations achieved through proper planning, faster implementations etc.

4. It will reveal the management’s weakness to operate a viable company e.g. failure in credit control policies, financial controls etc.

5. It does not disrupt the client’s work as it deals with human attributes for organisation, controlling and directing of human resources of the company.

Disadvantages of Management Audits1. It may lower the morale of the top management. 2. It may lead to biased reports because the attributes of efficiency are difficult to

measure. 3. The audit is time consuming if conducted for large company whose managerial

tasks demand constant reviews. 4. In case of organisation with many subsidiaries (branches) this audit may be

expensive as the auditor will have to visit each of the subsidiaries/branches to assess the efficiency of each manager in the light of the company’s total performance.

2.2.5 Final/ Complete/ Periodic AuditsThese are audits conducted at the end of the financial period, usually in one session and it is ideal for businesses which are small and whose transactions can be audited in one session. Advantages of Final Audits

1. It is easier to programme, plan and execute as it takes place in one single session at the end of the year.

2. It eliminates the possibility of alterations of figures, since it is the last audit. 3. It is a less expensive audit as compared to continuous audit because it demands

less time on the part of the auditor. 4. In final audits the auditor is able to give his client a balanced opinion and advice

based on the final circumstances. Disadvantages of Final Audits

1. If any fraud is committed and detected at the end of the financial period, it will have reached advanced stages, hence resulting to losses for the company.

2. It may be difficulty to conduct for large company.


3. Due to time constraints, such audits may not be exhaustive so as to enable the auditor give a balanced opinion.

Revision Questions 1. Write short notes on the following:

i. Continuous audit ii. Interim audit

iii. Procedure audit iv. Management audits v. Final audits

2. Distinguish between statutory and private audits

TOPIC 33.0.0 AUDITORS APPOINTMENT AND REMOVAL

Most audit work is conducted for companies and is governed by the rules of the Company Act 1985 as amended by the Company Act 1989. Cap 110

3.1.0 Appointment of Auditors This can be done in the following ways:- a) Appointment by the Annual General Meeting (AGM) s.159

The Co Act requires that the auditors should be appointed by and therefore answerable to the shareholders. The general rule is that auditors are appointed by shareholders at the AGM and once appointed holds office till the next AGM.

b) Automatic AppointmentIn this case, a retiring auditor is deemed re-appointed without any resolution passed unless:-

o He is not qualified for reappointment. o It is stated that he shall not be reappointed. o He has given a notice in writing that he is unwilling to be re appointed.

c) Appointment by DirectorsThe directors may appoint the first auditors of a company before the AGM. They hold office till the first AGM. Shareholders may appoint the first auditors if the directors do not appoint one before the first AGM. The appointment by the directors is done under the following circumstances

o When delegated by shareholders o Before the first AGM o To fill the casual vacancy .

Casual vacancies may be created by death or incapacitation of the auditor. In such situations, the directors may fill any vacancies in the office of the auditor, however if such a vacancy is created by the resignation of the auditor, then such can only be filled by shareholders at a general meeting.

d) Appointment by the Registrar of CompaniesWhen no auditor has been appointed at the AGM, or in case the directors do not appoint the first auditor, the Co Act requires the company to inform the registrar within one week. The registrar may then make an appointment.

3.2.0 Remuneration of auditors s.159 The remuneration of auditors is fixed either by: - a) Whoever made the appointment, which could be: -


o The shareholder o The directors o The registrar of companies.

b) The company in a general meeting or in such a manner determined by the GM.Note: the auditors’ remuneration is fixed and it must be disclosed in the annual accounts of the company.

Removal of an auditor s. 160An auditor can only be dismissed by shareholders in a properly convened G.M. This safeguards his independence. An auditor can be dismissed at any time at the end of his term of office. This removal is by ordinary resolution at the meeting with special notice (28 days) having been served.

Removal Procedure. i. Special notice is needed for a resolution at the GM appointing another

auditor or expressly stating that the retiring one shall not be reappointed. ii. A copy of the notice must be sent to the retiring auditor.

iii. Where a retiring auditor makes written representations regarding the resolution, the shareholders should be sent copies of representations.

iv. If the representations are not sent, they should be read out in the meeting, unless the court has ruled it out.

v. The auditor has a right to defend himself at the meeting. N.B. Removal procedures allow members to appoint auditors of choice and it safeguards the auditors’ independence by not allowing directors to remove auditors. These procedures ensure that the auditor is not removed for improper reasons without the knowledge of the shareholders.

Reasons for removali. Disagreements on accounting policies, audit findings. Where

directors feel the auditor is taking unreasonable stance. ii. Rationalization – subsidiaries having one firm with the holding

company. iii. Incompatibility between management and auditor. iv. Threat to expose management fraud. Auditor threatens to expose

management fraud or curb management’s unrestricted use corporate resources (via additional disclosures for instance).

v. Incompetence of the auditor. vi. Change of ownership of the business.

vii. Change of requirements of the client firm e.g. after expansion.

Resignation of auditors An auditor may resign due to:

o Ill health o Expansion of the client firm o Inadequate fees o Management fraud etc.

Revision Questions1. Kent ltd was formed on 1st February 2000 in order to export roses to European markets. The directors are unsure as to their responsibilities, and the nature of


their relationship with the external auditors. The audit partner has asked you to visit the client and explain to the directors the more fundamental aspects of the accountability of the company and their relationship with the auditor.

Explain to the directors; a) Why there is need for an audit b) How the auditor of a public co. may be appointed under the Co. Act. c) What are the auditors’ rights?d) The responsibilities of the directors to the accounting function of the company. e) What are the statutory responsibilities of auditors?

2. An auditor must always approach his work with integrity and objectivity. The approach must be in a spirit of independence of mind.

Briefly explain the matters that may threaten or appear to threaten the independence of an auditor.

TOPIC 4 4.0.0 INTERNAL CONTROL SYSTEMS (ICS)Internal ControlsThese are processes affected by the entity’s board of directors, management and other personnel designed to provide reasonable assurance regarding the objectives of an organization. ISA 315; “Understanding the Entity and its Environment and Assessing the risk of material misstatements “, requires the auditor to perform risk assessment procedures to obtain an understanding of the entity its environment, including its internal controls. This standard defines Internal Control System as comprising of control environment and control procedures.It includes all the policies and procedures adopted by management to assist in the objective of achieving as far as practicable; the orderly and efficient conduct of the business. Control EnvironmentThis means the overall attitude, awareness and actions of directors and management regarding ICS and its importance to the entity. It encompasses personnel policies and procedures, organization structure etc.Control Procedures These are procedure established to achieve the entity’s objectives. These objectives may include proper authorization, timely and accurate recording of transaction in the correct period, safeguarding of assets etc. These procedures differ from entity of entity and depend on the size of the firm. Internal Control Systems may also be defined as:-“The whole system of controls, financial and otherwise established by the management in order to carry on business of the entity in an orderly and efficient manner, safeguard the assets and secure as far as possible the completeness and accuracy of the records.”4.1.0 Types of Internal Controls The types of Internal Controls can be categorized as; 1. Plan of the Organization / Organisation chart An organisation should have a preplanned organisation chart that should define;

a) Duties and responsibilities of each individual in the organisation. b) Responsibilities such that it defines lines of reporting for all operations within the

organisation.


c) The flow of authority and responsibility, which should be clearly defined to avoid conflict in duties, authority and power.

d) How duties should be delegated in particular financial and accounting duties or assignments.

2. Segregation /Division of DutiesThis control means separation/division of duties and all responsibilities which if combined (i.e. not separated) will enable one single person to process and record the transactions from the beginning to the end hence exposing such persons to committing fraud. The main aim is to ensure that no one is responsible for the recording and processing of a complete transaction. 3. Physical Controls / Safeguarding of assetsThese aim at limiting accessibility of companies assets to authorized persons at authorized times. This control will take the form of physical measures which are also aimed at limiting direct access to assets using physical barriers e.g. being able to enter the warehouse. Or indirect limitations using documentation to company assets. 4. Authorisation and Approval ControlsThis is a control aimed at ensuring that all the company’s transactions are authorized by responsible officials whose limits of authority are defined such that they match transactions they authorise. Approvals should be segregated from authorisation e.g. all credit sales must be approved by the credit control department, all overtime must be approved by the works manager. 5. Arithmetic and Accounting ControlsThis is used to check the recording function in the organisation and to ensure that figures in the financial statements are not only genuine but also correct for accounting purposes. It requires the following measures:

a) Periodic reconciliation. b) Drawing the trial balance. c) Periodic balancing of accounts d) Control accounts, etc.

6. Personnel Controls/ competence of staff An ICS regardless of its application should be operated by personnel of integrity, competent and qualified to understand essence of the controls. Such people should have capabilities to carry out responsibilities assigned to them. It is normally achieved from the point of recruitment and retraining of staff. 7. Supervision. This has three levels. I.e.

a) Low level supervision. Such supervision should be manned by trained and competent supervisor who should supervise the company’s day-to-day operations such that they are carried out smoothly.

b) Middle level supervision. This is done by line managers who should ensure policies and procedures are adhered to and are in line with the company’s objectives and goals.

c) Managerial supervision and review. This is a management control done by the top management using such tools like budgets, standard costing statements, internal audit feed back, etc. All these aim at checking daily running of the organisation. It also involves reviews to ensure that all controls are working in harmony to achieve predetermined goals.

8. Rotation of duties and vacations.


Duties of routine nature should be rotated to avoid continuity of errors and fraud and also as a means of avoiding routine boredom, which may lead to innocent errors. Employees should also be encouraged to take leave when it falls due. 9. Routine and automatic checks.Controls conducted on routine duties and operations are important in that they ensure that these operations are carried on efficiently and such controls are operated at a surprise basis to minimize errors and frauds. 10. Recording and record keepingThe system of recording the business transactions at all stages should be complete and reliable. The records should be kept properly to avoid any losses or alterations.NB. Any ICS should be operated at such a reasonable cost so as to enable the company derive maximum benefits which should out weigh the cost of installation and maintaining such system.Objectives of an Internal Control SystemThe main objectives of Internal Controls are to ensure that:-

1. The business is carried in an orderly and efficient way. 2. All business transactions take place according to set procedures. It means that the

management policies are followed strictly. 3. The assets are safeguarded properly. The acquisition usage, and disposal of assets

must be duly authorised and in accordance with the company policies. 4. The records are complete and accurate. It means that all incomes and expenses are

recorded adequately and correctly. These are maintained in such a way that the possibilities of errors and frauds are minimised.

5. The records provide adequate and reliable information for the preparation of financial statements.

Advantages of Internal Control Systems 1. It boosts the confidence and gives assurance to third parties or stakeholders in

running the organisations preparations smoothly. 2. It helps the auditor to obtain reliable evidence. 3. It strengthens the financial controls and prevents errors and fraud within the

organisation. 4. It boosts efficiency of staff by segregation of duties, use of qualified staff and

proper use of the organisation chart. 5. It helps the company to have accurate and correct records. 6. It minimizes the cost of an audit as it facilitates an audit through minimization of

errors and fraud. 7. It facilitates accurate decision-making processes with accurate information from

controls, which will lead to the growth of the company. 8. It enables the auditor to avail management with quality advice through the

management letter, which will facilitate the company’s operations. Disadvantages of Internal Control Systems

1. It is expensive to install and maintain especially in small organisations. 2. It may lead to over reliance on ICS by management team and thus reduce its

supervision and give room to perpetrators and frauds. 3. The integrity, competence and quality of management changes and this will lead

to changes in control.


4. There is possibility that procedures may become inadequate due to changes in conditions and compliance procedures.

5. There is a possibility that a person responsible for exercising internal control could abuse that responsibility.

6. Most internal controls tend to be directed at routine transactions rather than non-routine transactions.

4.3.0 How the Internal Control Systems assist in detecting errors and frauds 1. Plan or the organisation chart.

o In defining the duties effectively, perpetration of frauds can easily be detected.

o Where powers conflict (duplication of efforts) such an area is grounds for errors and frauds.

2. Segregation of dutieso Segregation entails interchecking by superior colleagues thus errors and

frauds are identified with ease. o A person authorizing a transaction may want to perpetrate the fraud but

the executor may block the fraud. o A person keeping assets (storekeeper) can’t keep a fraudulent asset, which

has either been perpetrated by the executor or authorizer, as it is not a genuine business transaction. This is important because it prevents collusion between the authorizers, executors’ custodians and the recording parties.

3. Physical Control i.e. direct and indirect controls. o Indirect limitations (use of documentation) will give an idea of the

perpetration of frauds. This is achieved via the serialization of documents. o Physical barriers such as locked areas, strong rooms, safes etc. will show

actual frauds where there are shortfalls such as shortages and breakages. 4. Authorisation and approval controls

o Exceeding limits of authorisation will serve as a good indication of fraud. o Unauthorized transactions could be a sign of frauds.

5. Arithmetic and Accounting controls Trial balances not balancing should reveal

o Frauds and errors, o Excessive changes of accounting figures. o Out of balance account is an indication of frauds.

6. Supervisiono Supervisors are people of integrity thus will reveal frauds perpetrated to

avoid being victimized. o Managerial reviews, out of balance budget/ balance forecasts will give a

clue to frauds. o Where procedures are not adhered to due to relaxation of supervisor will

give room to frauds. 7. Personnel

o Qualified people will not normally allow frauds to pass their way. o Properly remunerated personnel will reveal frauds committed by lower

level employees under them. o High turnover of qualified personnel will serve as an indication of frauds.

8. Rotation of duties and vacations


o Once a person has been rotated, the incoming person will be able to detect any fraud if any. This also applies for a person gone for leave.

o Reluctance to be rotated or go for leave may indicate presence of frauds. 9. Routine and automatic checks

o Perpetrators of fraud are normally caught unaware with surprise checks. o Periodic, routine and automatic checks will detect errors and frauds

perpetrated. 10. Control over documents

o Missing pre numbered and serialized documents will reveal frauds. o Unauthorized documents or forged documents will also reveal frauds.

4.4.0 TECHNIQUES USED TO ASSESS THE STRENGTH OF THE ICS 1. Internal Control Questionnaires (ICQ)This is a set questions posed by the auditor to be answered by the client directly or indirectly. These questions require short answers like yes or not. E.g. Was Local Purchase Order authorized? Yes answers show the strength of ICS, where as No indicates weakness of ICS. Illustration of an ICQ

Question nos. Questions Answers Remarks1 Who raised the LPO None Weak ICS2 Was it authorized? No Weak ICS3 Was it recorded? No Weak ICS4 If so, who recorded it? N/A Weak ICS

2. Use of Systems NotesIt is a record of ICS, which describes operations of entire ICS and outlines where the ICS is weak and how serious the weaknesses are. 3. Use of third party confirmation (circularization)An auditor uses a source to gain valuable and reliable information from sources like debtors, creditors, bankers, lawyers, etc. Any difference between the third party evidence and evidence from company’s own records is a sign of weak ICS. 4. Use of Compliance tests.These are tests that analyses the client’s records and recording system to ascertain whether they are working as expected ICS. The question is ‘Do they comply with the company’s laid down policies?’ If the results of these tests indicate a strong control system then the auditor reduces the volume of substantive tests. 5. ObservationThis technique reveals deviations from usual conduct of operations. These observations are made in areas such as wage payments, stocktaking cash counts etc. Any deviations from laid down policies are an indication of weak ICS. 6. Flow ChartsThese are grammatical representations of the company’s procedures designed to show movement of documents within the organisation. Any destruction in the flow lines or blocked flow line is assumed to be an indication of weak ICS. 7. Analytical Reviews


These are trend measurements aimed at analyzing company’s performance say by use of ratios to determine normal changes. If the changes of the deviations are not justified, it could indicate weakness in the ICS. 8. Use of Depth TestsThis involves the checking of a transaction through various stages of recording , analyzing each stage to ascertain whether the controls are working through out such stages. 9. Use of Walk through tests.These are limited tests aimed at ascertaining the strength or otherwise of an ICS. In order to follow a particular sequence relating to a single transaction, it may be best to follow through a few typical or similar transactions. 4.5.0 Differences between Internal Control Systems (ICS) and Internal Checks (IC). An Internal Check System is part of Internal Control System where duties or functions of an individual are independently checked by his colleagues. The essence of ICS is to ensure that any given function is counter checked to avoid possibility of frauds and errors. The differences between ICS and IC include the following:

1. An internal control system is a broad spectrum of controls aiming at ensuring that the organisation is run efficiently where as an internal check system is aimed at preventing errors and frauds.

2. The internal control system is necessary for all businesses regardless of their size where as an internal check system is ideal for large companies, which require strong segregation of duties.

3. An internal control system is operated by competent and qualified personnel whereas an internal check can be manned by any person regardless of his qualifications.

4. The weak ICS may lead to a qualified report where as internal check may not lead to a qualified report.

Actions to be taken by the Auditor if the ICS is weak 1. He should bring such weaknesses to the attention of the management immediately

and request for corrective measures to this effect. 2. The auditor should increase substantive tests. The auditor should increase the

volume of tests to ensure that he gathers sufficient audit evidence. 3. The auditor should change his audit approach in areas where the ICS is weak .eg

from system-based audit to vouching audit and auditing in depth. 4. If the weaknesses persist year after year the auditor should bring this to the

attention of the shareholders so as to take appropriate action. 5. If ICS are too weak to allow testing, the auditor should qualify his report on the

strength of the fact that he is unable to get all the information and explanations he considers necessary for the purpose of his opinion.


TOPIC 55.0.0 INTERNAL AUDITING Internal audit can be defined as 'an independent appraisal function established by the management of an organisation for the review of the Internal Control System as a service to the organisation'.Internal audit is an element of the internal control system set up by the management of an enterprise to examine, evaluate and report an accounting and other controls on operations.

Scope and Objectives of IA1. Review of accounting system and related internal controls.

2. Examining the financial and operating information for management. This may include review of the means used to identify measure, classify and report such information.

3. Reviewing the economy efficiency and effectiveness of operations and of the functioning of non-financial controls. This can be done through routine and automatic cheeks, periodic reviews and surprise checks.

Routine and automatic checks - are checks on the procedures and items prone to misuse or misappropriations e.g. stock, petty cash, wages payment etc.

Periodic reviews are conducted on company activities that are subject to abrupt change. The review is to ensure that they conform to laid down procedure policies e.g. budgets.

Surprise checks are checks on sensitive assets that are desirable, portable and viable to prevent their misuse through unauthorized access.

4. Review of the implementation of corporate policies, plans and procedures.

5. Special investigations. 5.1.0 Functions of Internal Auditors An Internal Auditor ensures the following:

1. Detection of errors and fraud. 2. An effective system of internal control in place. 3. Continuous effective operation of such systems 4. Adequate management of information flow 5. Asset safeguarding 6. Adequate accounting system in place. 7. Compliance with statutory and regulatory requirements.

Functions of Internal Auditing1. It acts as a consultant department on matters of controls e.g. financial controls,

personal controls etc. 2. It ensures that the organization has strong ICS, which will enhance efficient and

orderly running of the organization. 3. It serves as a preventive measure against errors and frauds, and as such ensures

safety of the company's resources.


4. IA safeguards the company’s assets through strong controls and as such it ensures that the company assets are used by authorized persons and for the right purpose.

5. This function conducts special investigations in such areas:- a. Where frauds and errors are suspected. b. Where profit margins have fallen for no apparent reasons etc.

6. The department performs routine duties such as verification of assets and liability, surprise checks etc.

7. IA performs executive duties such as designing of policies and execution or supervision of board directors, all of which are aimed at ensuring efficient organization policies.

5.2.0 Limitations to setting up an Internal Auditing function 1. Size of the organization may be too small to warrant the function. 2. The cost of installing and maintaining the internal auditing function may be too

high. 3. If operations are few, the function may not be necessary. 4. The ability of staff (qualified and competent) to operate the function may be

unavailable. 5. Lack of cooperation on the part of management. 6. The company’s technical aspects.

5.3.0 Areas/ ways which in Internal Auditors can assist External Auditors 1. Identify areas in which the ICS’s are weak. This will enable the external auditor

to plan his audit work to concentrate his effort in those areas. 2. The internal auditor will pin point technical matters over which the external

auditor may not have sufficient knowledge e.g. technical assets. 3. The internal auditor will pinpoint areas where there are fundamental changes in

management and ICS. 4. He undertakes routine duties on behalf of the external auditor such as, branch

visits, stocktaking, wage payment etc. all of which will assist the external auditor. 5. The internal auditor may prepare schedules for the external auditor e.g. creditors,

debtors and assets schedules, which are useful for comparison purposes and for final review.

6. He makes inquiries/queries and undertakes observation over operations on behalf of the external auditor.

7. The presence of an IA boosts the moral of the accounts staff thereby keeping their accounts to date.

5.4.0 Factors to consider before the external auditors can rely on the internal auditors work. Before placing reliance on the work of an internal auditor, it is necessary to make assessment of the likely effectiveness and the relevance of the internal audit function. The criteria for making this assessment should include the following:-

1. Degree of independence: The external auditor should evaluate the organisation status and reporting responsibility of the IA and consider any restrictions placed on him. Although an IA is an employee of the organisation, he should be able to organise his work and have access to the highest level of management. An IA should also be free to communicate freely with the external auditor.

2. The scope and objectives of the IA function: The EA should ascertain the scope and objectives of IA assignments. This enables the EA to consider the relevant assignments.


3. Due professional care: To be useful to an external auditor, the internal auditor's work must be done in a professional manner. It must be properly planned, controlled, supervised, recorded and reviewed example of the exercise of due professional care by internal auditor are:- existence of an audit manual, general internal audit plans etc.

4. Technical competence: The EA should ascertain whether the work of the internal audit is performed by persons having adequate training. Indications of technical competence may be membership of an appropriate professional body or the possession of relevant practical esp.

5. Reporting standards: The EA should consider the quality of reports issued by internal audit and ascertain whether management acts upon the reports.

6. Resources available: The EA should consider whether IA has adequate resources e.g. in terms of staff and computer facilities.

Differences between an Internal Auditor and an External Auditor Internal Auditor External Auditor

1. Does not have to be a certified accountant.

1. Should be a certified accountant.

2. An employee of the organization. 2. An independent contractor.3. Is paid a salary for service. 3. Paid fees.4. Appointment by management. 4. Appointment as per the Company Act.5. Report addressed to the management.

5. Report addressed not only to the management but also to shareholders and other stakeholders.

6. Main objective is strengthening controls.

6. Main objective is to prove the true and fair view.

7. Removal of the auditor is by the board.

7. Removal is as per the Company Act s16o.

8. Not liable to third parties. 8. Liable to third parties.9. Does not have to attend the AGM.

9. Has a right to attend the AGM.

10. Report if bad has no effect on the company.

10. Report if bad may be very disastrous to the company.

11. Not liable to professional misconduct unless certified.

11. Liable for professional misconduct.

12. Scope is limited. 12. Scope is open.13. Has no obligations. 13. Bound by the Company Act.

Revision question The directors of one of your expanding client have decided to appoint an IA. Required:

a. Describe the essential similarities and difference between an internal auditor and an external auditor.


b. State the advantages of this appointment to the co. c. What factors should the EA consider before he relies on the IA's work?

TOPIC 66.0.0 AUDIT MANAGEMENT6.1.0 Audit planning An audit plan:

Is the formulation of the general strategy for the auditor? Which sees the direction for the audit Describes the expected scope and conduct of the audit, and Provides guidance for the development of the audit programme.

Audit planning refers to the arrangement of audit work to be performed in respect to a particular audit assignment.Purpose/advantages of Audit planning

1. Helps to define the objectives and scope of the audit. 2. It increases efficiency, in that, the plan will enable the auditor to concentrate his

audit effort in key areas of an audit and avoid wasting time on routine matters.

3. Audit planning helps the auditor to complete his audit work in time so as to meet such deadlines as:

a. The AGM b. Income tax returns c. Returns to the registrar d. Financial commitments etc.

4. It enables the auditor to make optimal use of audit staff available so as to enable him conduct efficient audits in an exhaustive manner and above all, to avoid any delays in a given part of the audit work.

5. It also enables the auditor to control his audit work, for it is impossible to control an audit that has not been planned.

6. It facilitates the co-operation between the auditor, his assistant and his client. This cooperation:

a. Avoids delays b. Enables the auditor obtain important documents from the client c. Conduct interviews and reviews of the client’s activities.

7. Audit planning takes into consideration the volume of transactions. The size of modern business is such that the volumes of transactions are numerous, and as such, without proper audit planning, an auditor cannot finish his work in time.

8. It ensures that potential problems are identified and given due attention.

Knowledge of the client's businessAudit planning enables the auditor to conduct efficient audits in an effective manner, and to complete his work in time. For this reason he should have a good knowledge of the client's business. Sources of knowledge.

a) Previous experience of the client and its industry. b) Discussion with contacts within the client management and senior operating

personnel.


c) Discussion with internal audit personnel and review of internal audit reports. d) Discussion with other auditors and with legal and other advisors who have

provided services to the client. e) Discussion with knowledgeable people outside the client. f) Publications related to the industry. g) Visits to the client’s premises and plant factories. h) Documents produced by the client.

Audit planning procedures. This includes the following:

a) Consider the background to the clients business, and attempt to ascertain any problem for that sector of industry or commerce, which may affect the audit work. This is more important in case of a new client and is done during the initial visit.

b) Consider an outline plan of the audit including the extent to which he may wish to rely upon internal controls and extent to which work can be allocated to interim or final audit stages where appropriate.

c) Review matters raised in the audit of the previous years, by examining the audit files and discussing points with staff previously involved in the audit to ascertain those facts which may have relevance to the current year.

d) Assess the effect of any changes in legislation or accounting practice on the financial statements of the client.

e) Review any management or interim accounts the client may have prepared as these may indicate areas of concern in his audit.

f) Meet the senior management of the client to identify problem areas e.g. variances between the budgeted and actual results, changes in the accounting system, staffing, management structure etc.

g) Discuss with management the extent to which the client’s employees will assist in the audit work.

h) The auditor will need to determine the number of audit staff required, their experience and special skills they need to possess and the timing of their audit visits.

6.2.0 Audit ProgrammeIt is a detailed approach to an audit showing procedures and relevant items in carrying out an audit. Its formulation is based on the overall audit plan and the nature of the client. The audit programme provides the instructions to the audit team in form of tests or activities to be carried out during the audit. Factors to consider in developing an audit programme

Risk of error; high risk detailed programme low risk, less detailed programme. The necessary audit evidence needed to fulfill the procedure. Some areas of

audits requires more evidence and therefore more instruction are given for such areas compared to those whose audit requires little evidence.

Coordination of audit work with any work on preparing the financial statements. Timing of tests of control and substitute procedures. Coordination of any assistance from the entity. The composition of the audit team.

The involvement of other auditor or experts. NB: The level of detail in the audit programme will depend on the complexity and size of the client and the issues there to.


Objectives of an audit Programme1. It assists in ensuring that the audit work is done efficiently and effectively to meet

the overall audit strategy or plan. 2. It’s intended to provide clear instructions and timing of procedures to audit staff 3. Provides a record of work done and conclusions made and therefore can be used

as a defense against an action for negligence 4. It aids audit control as it forms basis for audit review. (Through cross

examination). Characteristics of good Audit programme.

Should describe the nature of audit procedure in detail. It should indicate the extent of testing; audit checking It should show against each procedure across reference to working papers, initials

of the audit staff, date of completion of the work, exceptions and how they are cleared.

Note: Each area of the audit must have its own audit programme e.g. audit programme for payroll, company consumables, Noncurrent assets, investments of the company etc.

Amendment of Audit ProgrammeThe audit programme is prepared before the audit commences and on some assumptions.On the commencement of the actual audit, these assumptions may have changed and hence a need to change the audit programme. Below are some of the factors that may necessitate a change in the audit programme;

The accounting system or computer software may have been changed by the client. Eg change to specialized self balancing ledges from general journal and ledger.

There may be ground for suspicious of fraud. The amount of audit work might have been under estimated. The client business may have expanded its operations or contracted part of it or

cutting the size down Change in the accounting policies.

Standard audit programme.Is a pre-prepared audit program for use in the audit firm by all audit staff irrespective of the client. Advantages of standard audit programme

It ensures that all work is completed on time without any omissions. Its used to monitor the progress of the audit Enhances uniformity of work for audits across periods It facilitates allocation of audit work and assessment of staff competencies It facilitates the final review as it provides summaries of what is to be checked

(and this done normally by the audit partner). It serves as a record of work done and therefore can be used as evidence for any

action of negligence. Disadvantages of the standard audit programme.

It may be followed mechanically leaving some areas of importance without proper understanding of what is done.

It may destroy the innovativeness of the audit staff and may slow their development in the audit field.


It may leave errors and fraud undetected as it may be followed without due attention and profession skills

Audit clerks may hurriedly try to finish on time leaving some work unchecked Familiarity with the audit program may facilitate fraud by the client staff

Precautions to be taken when the audit programme is standardized

Encourage the audit staff to point out any defects in the programme Encourage the audit staff to use the programme as a guide but to apply

professional judgment Revise the audit programme often Allocating responsibility for each audit staff who are encouraged to keep the

overall perspective in mind. Plan audit checks in such a way as to prevent parts of the programme being

completed in isolation. 6.3.0 Audit riskWhen planning the audit, the auditor should assess the risk of the client he is to handle in order to assess the extent and nature of the work he is to perform. The riskier the client, the more the auditor will plan to perform.

Audit risk is the chance that an auditor may give a wrong opinion on the financial statements i.e. he may issue a qualified report when actually there were no material errors in the financial statements or he may issue an unqualified report when actually there were material errors. The effect of audit risk is damage to the audit firm (e.g. in form compensation to third parties) or loss of reputation with the client or the business community.

Audit risk has three components:a) Inherent risk Refers to the risk of material errors in the financial statements arising from characteristics of the client business and its environment, some of the characteristics include:

o Dominance by a single person o The experience a unqualified staff o Unusual pressures on management e.g. tight reporting deadlines. eve.

b) Control risk. Refers to the risk that the client's controls in place will fail to detect or prevent material errors or frauds in the financial statements.Factors to be considered may include:-

o Quality and effectiveness of management (degree or supervision) o Quality of IC e.g. poor segregation of duties. o Competence of accounts staff o Accounting system etc.

c) Detection risk. Is the risk that audit procedures will fail to detect material errors or fraud e.g.

o Failure to draw proper conclusions in particular audits evidence. o Failure to perform necessary audit work due to limited time or high cost

e.g. missing stock taking, wages payment etc. 6.4.0 Audit control (Quality Control)


Audit control refers to the steps which are taken by the auditor to ensure that the actual audit carried out is as per the audit plan.Quality control refers to the procedures organised to ensure that audits are performed:-

a. In accordance with approved auditing standards. b. In conformity with statutory and contractual requirements. c. In conformity with any professional standards. d. Economically and to time schedules e. With minimum risk.

Quality control policies and procedures should be implemented both at the level of the audit firm and at the level of individual audits. Quality Control at Individual Audit LevelThe following ways can be adopted to control the audit:-

i. Allocation of work. Work should be allocated to audit staffs that have appropriate skills and competence to carry out the assigned tasks.

ii. Proper briefing. Ensure that audit staffs of all levels clearly understand their responsibilities and the objectives of the procedures, which they are expected to perform.

iii. Audit completion check list. It is a common experience that in the rush to complete an audit on time, matters of importance may be overlooked. So it is necessary to go through the checklist to make sure that everything is covered.

iv. Documentation. All audit work and conclusions reached must be fully recorded in the working papers.

v. Review. The work performed by each member of the audit must reviewed by more senior persons in the audit firm. This is necessary to ensure that the work was adequately performed and to confirm that the results obtained, support the audit conclusions which have been reached.

vi. Acknowledgement. All audit work and review action should be acknowledged in writing by the performer.

vii. Supervision. Personnel with supervisory responsibilities should monitor the progress of the audit to consider whether:-

Assistants have the necessary skills and competence to carry out their tasks.

Assistants understand the audit direction, etc. Quality Control at the Level of the Audit Firm. The procedures include:-

1. Acceptance and retention of clients. This involves screening prospective clients and reviewing existing clients in terms of independence, ability to properly audit the client and the integrity of the client’s management.

2. Professional Ethics. There should be procedures within the firm to ensure that all partners and professional staff adhere to the principles of independence, objectivity, integrity and confidentiality.

3. Skill and Competence. The firm’s partners and staff should have attained the skills and competence required to fulfill their responsibilities. This involves procedures relating to

a. Effective recruitment b. Technical training and up dating c. On the job training and professional development


4. Assignment. Audit work should be assigned to audit staff who have the technical training and proficiency needed to do the work.

5. Delegation. Sufficient direction, supervision and review of work at all levels. This includes the use of audit programme and standard documents.

6. Consultation. There should be procedures for consultation. Individual members of the firm should not take decisions on problems areas without consultation with others. Problem areas may be technical or a matter of risk.

7. Monitoring the firm’s quality control procedures. Suitable procedures should be introduced to monitor the effectiveness of the application of quality control procedures outlined above.

6.5.0 Audit recording (Audit working papers) Audit recording refers to documentation of audit work in form of working papers (WP). WP are the materials the auditors prepare or obtain and retain in connection with the performance of the audit. WP may be in form of data stored on papers, films, electronic media etc.The auditor should document all materials, which are important in providing evidence to support his/her audit opinion, and should show compliance with audit standards. In other words, WP should:-

o Record auditor's planning, nature, timing and the extent of audit procedures performed and conclusions made from evidence obtained.

o Include matters such as auditor's reasoning, judgment and conclusions. o Acts as evidence of work done to support his conclusion

Importance/ purpose/ advantages of WP1. WP are used as a basis for planning subsequent years’ audits because the starting

point of a given year's audit (especially for existing clients) is a review of the previous year's WP.

2. They provide evidence of work done in case of threat of or action taken against the auditor for negligence. I.e. WP show evidence of appropriate audit procedures carried out and conclusions reached.

3. They assist the manager in reviewing the audit work and the reporting partners in reaching an audit opinion i.e. whether the financial statements portray a true and fair view of the company's performance.

4. They are also used to control audit work, in that the best audit control is effected through the review of documentation.

5. WP enables the auditor to adopt methodical approach to his audit work and by so doing, adhere to laid down professional standards and the audit firm's own standards. This in turn improves quality of audit work.

N.B: Working Papers are the property of the auditor, but at his discretion, he may give the client extracts or portions of such working papers.

Audit files Normally an auditor maintains two files of WP for each client i.e.

o The Current Audit File o The Permanent Audit File

Current Audit File (CAF)This contains information relevant to the current year's audit.


Contents:1. A copy of accounts and statements which the auditor is reporting on. 2. An index to the file 3. A description of the internal controls in form of an ICQ, flow charts, etc. 4. An audit programme. 5. A schedule for each item in the balance sheet. 6. A schedule for each item in the profit and loss account. 7. A checklist for compliance with statutory disclosure requirements, accounting

standards and guidelines. 8. A record of questions raised and answers obtained and if not satisfactorily

answered, what course of action to be taken, a qualification of opinion. 9. A schedule of important statistics. 10. A record or abstract from the minutes of the company, directors etc. 11. A copy of the management letter that highlights the weakness of the internal

control system. 12. Letters of representation which are written by the directors or their representatives

to the auditor. Permanent Audit File (PAF) This contains information of a long-term nature or matters of continuing importance to the auditor, which will be used for a period beyond one audit.Contents of PAF

1. Statutory material governing the conduct of accounts and audit of enterprises.e.g company act, accounting and audit standards, etc

2. Rules and regulations of the enterprise e.g. the Memorandum of Association, Articles of Association, Partnership Deed, etc

3. Documents of continuing importance to the auditor. e.g. letters of engagement, trade licenses, debenture deeds, leases etc

4. Address of the registered office. 5. The organization chart showing principle departments and their sub-divisions. 6. A list of books and other records, which are kept, names, positions and specimen

signatures of people keeping such records. 7. A list of accounting matters of long-term use to the auditor e.g. accounting

policies used by the organization for instance depreciation methods. 8. The clients internal auditing and accounting instructions. 9. A list of directors, their shareholding and service contracts. 10. A list of company properties and investments with a note of verification. 11. A list of company advisors, bankers, insurance brokers etc 12. A list of the company’s insurance on all properties.

Revision Questions 1. You are the manager responsible for the audit of Kent Ltd, which has a number of branches selling household goods. The company has an annual turnover of Shs. 1200m Required:

a. Describe the work you would carry out in planning the audit prior to commencement of detailed audit work.

b. Outline the procedures you would carry to control the audit. 2. You are the audit manager in charge of TLC Co ltd, whose financial year ended on 31st Dec 2000. Due to the tight schedule of your programme, you are unable to devote


any time at the client’s premises; therefore you have delegated the responsibility to the auditor senior. Required:

a. State the procedures you would follow to control the audit up to the completion stage.

b. Explain the matters you would pay attention to in order to achieve your firm’s quality control targets.

3. The auditing guideline on ‘recording’ requires audit working papers to be sufficiently complete and detailed so that an experienced auditor who has no previous connection with the audit is able to ascertain from working papers the work performed and to further support the conclusions reached. Required:

a. State four benefits that the auditor will obtain from the working papers. b. Outline the contents of a typical:

i) Current audit File ii) Permanent Audit File 4. The auditors’ operational standards require an auditor to adequately record his work.

a. Explain the main purposes, of audit working papers . b. State four main contents each for a Current Audit File and a Permanent

Audit File. c. State four main characteristics of good working paper file.

6.6.0 COMMENCEMENT OF AN AUDIT An audit may be:

o A New clients audit o An Existing clients audit

6.6.1 Audit of new clientsBefore acceptance of an engagementProcedures carried out by the auditor before accepting new engagements are as follows:-

1. Ensure the audit staff are professionally qualified to act.2. Ensure that the audit firms existing resources are adequate to handle the new

client i.e. in terms of available time, staff, technical expertise etc.3. Obtain references in respect to the new client’s status and its directors.4. Ascertain the degree of independence with respect to the client from the point of

view of: a. Blood relations b. Financial relations c. Goods and services etc

5. Obtain clients permission to communicate to outgoing auditors, which is necessary for the following reasons:

i. It is the requirement of the professional bodies ii. It acts as a basis of obtaining the previous years working papers from the

previous auditors. iii. It helps the auditor to gain assurance about the clients internal control

systems. iv. To find out why they are no longer the auditors of the client. v. To obtain the previous years copies of financial statements.


vi. To establish whether or not to accept the engagement. Procedures after accepting the engagement

1. Ensure that the out going auditors removal or resignation has been in accordance with the Company Act. This includes a valid resignation notice or proper legal removal procedures.

2. Ensure that the new auditor’s appointment is valid. Obtain a copy of the resolution passed at the general meeting.

3. Meet with the client to agree the scope of the audit. 4. Prepare and submit a letter of engagement to the client. 5. The client should be asked to acknowledge the letter.

6.6.2 Audit of existing clientThe following steps should be followed when auditing existing clients.

1. Obtain instructions from the client as regards to the scope and objectives of the audit assignment.

2. Check the audit file to ascertain:a. The financial position of the client in the previous year. b. Previous years internal control systems c. Previous years audit plan, audit programme, etc

3. Request for management information regarding changes in the business, changes in management, accounting systems, etc.

4. Evaluate the internal control systems of the client.5. Design audit programme and commence on audit work.

6.6.3 THE ENGAGEMENT LETTERAn engagement letter is a letter of acceptance, prepared by the auditor before commencing a new audit. It specifies the respective responsibilities of the auditors and directors, and lays down the scope and objectives of the audit work.Purpose of the engagement letter

1. It defines the objectives and scope of audit work to be performed by the auditor. 2. It explains the duties of the auditor and existing contract. This minimizes

misunderstandings between the client and auditors. 3. It explains the duties of the directors. 4. It confirms verbal arrangements between the auditors and the client i.e. it provides

written confirmation of auditors acceptance of appointment. 5. It serves to minimize any liabilities as the letter defines clearly the scope of what

is to be done and as such, avoids implied contracts. 6. It is used for audit planning purposes in that any audit plan must take into account

the amount of work that is to be done highlighted in this letter. Contents of the engagement letter

1. A statement of management’s responsibilities to keep proper accounting records and to prepare the financial statements.

2. A statement of the management’s responsibility for detection of fraud. 3. A description of the auditors’ responsibilities in forming their opinion on the

financial statements. 4. An explanation on the scope of the audit, stating that it will be carried out in

accordance with auditing standards. 5. An explanation that weaknesses in internal controls will be reported to

management in the management letter.


6. An explanation of the need to obtain written management representations in certain circumstances.

7. Details of the basis for charging and paying fees. 8. Applicable law governing the letter. e.g. the Co. Act. 9. A request that the directors accept the terms of the letter.

Revision question1. You have been approached by the management of Equity Co.ltd, a newly formed private company to undertake the audit of the company for its first complete financial year. You have held various discussions with the management about the respective responsibilities of management and the auditor. Consequently you have sent a draft letter of engagement to the managing director for approval and acceptance. Required:

1. Briefly set out the procedure for appointment of an external auditor. 2. Explain why a letter of engagement is sent before any new audit

appointment is accepted. 3. Outline the contents of a letter of engagement.

TOPIC 77.0.0 AUDIT EVIDENCE As per the International Auditing Standards, an auditor should obtain relevant, reliable and sufficient evidence to enable him draw reasonable conclusions.Audit evidence is that information obtained by the auditor in arriving at conclusions on which he bases his opinion on financial statements. Audit evidence provides the auditor the necessary assurance to determine the accuracy and reliability of accounting statements. Source of audit evidence:

o Company’s accounting systems o Underlying documentation. o Its customers o Suppliers o Third parties o Employees etc

Qualities of audit evidencea) SufficiencyIt means that audit evidence should be complete and adequate to prove any material fact. E.g. complete physical counting of stock is sufficient enough to verify the value of stock. b) RelevanceAudit evidence should be relevant to the purpose for which it is required. E.g.

Checking the existence of assets or liabilities. Ascertaining whether there are no unrecorded assets, liabilities or transactions. Ascertaining whether the given asset or liability or transaction has been recorded

at appropriate values etc. c) ReliabilityEvidence is reliable if it is considered correct and accurate. Reliability depends or is influence by the source, i.e. whether internal or external source. The following should be noted.


i. External evidence from such parties as bankers, debtors or creditors is assumed to be more reliable than internal evidence.

ii. Internal evidence is only assumed reliable if the company’s internal controls are working properly (strong).

iii. Audit evidence obtained by the auditor himself is more reliable than evidence obtained from the entity because evidence from the entity may be distorted.

iv. Evidence obtained from documents are more reliable than oral representations etc. 7.1.0. Types of Audit Evidence1. Documentation evidenceThis is evidence gathered from the company records and documents .The auditor should gather such evidence regarding to:

o The accuracy of the records o Authority of accounting records. o Accuracy of balances from ledgers.

2. Management and employees This will provide evidence regarding:-

o The strength or otherwise of an internal control systems. o The validity of the company transactions. o Operational efficiently of the company and its adherence the company

policies.

3. Tangible evidence or physical evidenceThis will avail evidence regarding the accuracy of the company’s balance sheet entries, value and existence of company assets etc. 4. Hearsay evidenceThis is evidence gathered from such sources as interviews and conversations with the top management. 5. Circumstantial evidenceThis is evidence obtained from the circumstances of the enterprise or situations prevailing in the organisation such as the position of the ICS, organisation structure, etc. 6. External evidence This is evidence obtained from third parties e.g. bankers, debtors, creditors etc. 7.2.0 Methods/ procedures of gathering audit evidence. a) InspectionThis is the examination of records, documents or tangible assets. The reliability of evidence depends on the nature and source and effectiveness of internal controls over their processing. The following presumptions are useful as regards documentary evidence:-

i. Evidence created and held by third parties such as bank statements, ii. Evidence created by third parties but held by the Company e.g. local purchase

orders, receipts, invoices etc. iii. Evidence created by the company, but held by third parties e.g. debenture deeds,

share certificates receipts etc. iv. Evidence created by third parties and held by third parties e.g. bills of exchange,

title deeds, treasury bills etc b) Observation.


This consists of evidence obtained by looking at the processes or procedures being performed by others e.g. stock taking, cash counts, wages payment etc. all of which are designed to assess the strength or otherwise of an ICS. However, observations are done to ascertain whether the companies laid down procedures are being followed.c) Inquiries and confirmationThe auditor makes inquiry from persons inside or outside the company in order to confirm some particular facts and information. E.g the auditor can seek opinion of some outsider experts to confirm the values of assets shown on the balance sheet. The auditor can also write to the bank manager and debtors to confirm their amounts due. Reliability on evidence depends on the competence and integrity of the respondent. d) ComputationsThis is the checking of the arithmetical accuracy of source documents and accounting records or performing independent calculations e.g. adding up ledger balances, depreciation calculations, stock valuations, payroll deductions etc. e) Analytical Procedures.This is the analysis of significant ratios and statistics, averages and percentages and investigations of any unusual variances.7.3.0 Problems or limitations of gathering audit evidence.

1. It is usually expensive to gather evidence especially from third parties where such third parties are numerous and geographically dispersed.

2. There may be lack of co-operation from the staff and to some extent third parties in availing audit evidence.

3. There are possibilities of collusion between management employees and third parties leading to distortions of audit evidence.

4. The business entity might be technical and as such difficult to gather evidence and the auditor has to use experts, which is not only expensive but also tedious.

5. There might be inadequate records or incomplete records, which may limit internal evidence.

6. There might be a problem of weak ICS especially in the client’s business, which will compromise the evidence obtained although weak controls among third parties may also compromise such evidence.

7. There may be changes in the company e.g. changes in the management, etc which may compromise the ICS and by extension audit evidence to be gathered.

8. Evidence from third parties may delay hence making it difficult to the auditor to form an opinion. Etc.

Revision Questions What is audit evidence? What are the techniques of audit evidence? What are the factors that influence the reliability of audit evidence?


TOPIC 88.0.0 AUDIT OF THE SALES, PURCHASES SYSTEM AND THE PAY ROLLGENERAL Control Objectives, Control Procedures and Tests of Control. Control Objectives.These show why we need internal controls. Generally the control objectives of all systems are:-

1. Only authorized transactions are promptly recorded at the correct amount in the appropriate accounts in the proper accounting period.

2. Access to Assets is only in accordance with proper authorization 3. Recorded Assets are compared with existing Assets.

Control Procedures.These are individual controls put in place to achieve the control objectives. Both are the responsibilities of the client. Detailed control procedures are often similar across sales, purchases and other areas and they include;

1. Sequential numbering of documents with subsequent checking of the sequence for completeness.

2. The maintenance of controls accounts, which are checked to ensure that they reconcile with ledgers.

3. Authorization evidenced by the signature responsible of officials for the raising inputting and distribution of the documents.

Tests of ControlTests of control involve auditors ensuring that the procedures above have been applied. This is done by looking for evidence e.g. checking of sequences, control Accounting reconciliations and authorization. Often the auditor looks for a signature to show that the procedures have been performed.Risks Associated with Sales and Purchases

1. Sales and purchases fail to meet the objectives of the organization, resulting in financial loss and damage to reputation.

2. In appropriate or expensive goods purchased resulting in missed budgets and financial loss.

3. Failure to purchase goods/services at the right time and therefore failure to meet required dead lines.

4. Fraudulent purchase or sales transactions resulting in financial loss or damage to reputation.

5. Poor quality of goods received and dispatched resulting in claims against the company, failure to achieve company objectives and damaging the reputation.

6. Failure to agree to appropriate terms and conditions with suppliers or customers resulting in disputes over sales and purchases.

7. Failure to meet regular requirement for goods sold or purchased. SALES SYSTEM Control Objectives

1. Sales are made in accordance with companies’ objectives with agreements in place with all customers.

2. Customers order should be authorized and recorded in order to execute them promptly and determine any allowance required for losses arising from fulfillment commitment


3. Goods returned and claims by customers should be controlled in order to determine the liability for goods returned and claims received but not entered into the Accounting records e.g. credit not in case of return inwards

4. Invoices and credit notes should be appropriately checked as being accurate and authorized being entered in accounting records.

5. There should be procedures to ensure that sales invoices are subsequently paid and that doubtful amounts are identified in order to determine any allowances required.

ACHIEVEMENTS OF OBJECTIVES ABOVEIn order to achieve above objectives there should be good segregation of duties. There are three distinct processes of sale system, which should be segregated and performed by different staff in order to establish effective internal controls. These are:-

1. Accepting customer’s orders. Sequence controlled documents should be used to acknowledge all orders received. Any uncompleted orders should be regularly reviewed. Credit limits should be checked by the credit control department selling prices, special discounts and delivery dates should be fixed by senior members of sales department.

2. Dispatch department. Sequence controlled documents should be used (goods outwards or dispatch notes) for all goods leaving the premises. These should be completed by the gate keeper or the dispatch department, never the accounts staff.

3. Invoicing the goods. Sequence controlled invoices should be raised by sales department and then passed to the accounts department for recording. Independent checks should be made to ensure that the invoices have been raised for all goods (outward notes). For every goods outwards there should be outward notes.

Control Procedures over Sales and ReceivablesThere are a number of controls that may be required in the sales cycle due to the importance of this area in any business.a) Orders

i. The orders should be checked against the customer’s accounts. Any new customer should be referred to the credit control department before the order is accepted.

ii. Existing customers should be allocated a credit limit and it should be ascertained whether this limit is to be exceeded if the new order is accepted.

iii. All orders received should be recorded on pre-numbered sales order documents.

iv. All orders should be authorized before any goods are dispatched. v. The sales order should be used to produce a dispatch note for the goods

outwards department. b) Dispatch.

i. Dispatch notes should be pre-numbered and a register kept of them to relate to sales invoices and orders.

ii. Goods dispatch notes should be authorized as goods leave and checked periodically to ensure they are complete and have all been invoiced.

c) Invoicing and credit notes i. Sales invoices should be authorized and referenced to the original

authorized order and Dispatch note.


ii. All invoices should be entered in the:- sales daybook records, the accounts receivables ledger and accounts receivable ledger control account.

iii. Sales invoices and credit notes should be checked for prices, casts and calculations by a person other than the one preparing the invoice.

iv. All invoices and credit notes should be serially pre-numbered and regular sequence checks should be carried out.

v. Credit notes should be authorized by someone not connected with dispatch.

vi. Copies of cancelled invoices should be retained. vii. Any cancellation of an invoice should lead to the cancellation of the

appropriate Dispatch note. viii. Cancelled invoices should be signed by a responsible official.

d) Receivablesi. A receivables ledger control account should be prepared regularly and

checked to individual sales ledger balances by an independent person. ii. Receivables ledger personnel should be independent of dispatch and cash

receipt functions.(segregation of duties) iii. Statements should be sent regularly to customers. iv. Formal procedures should exist for following up overdue debts. v. Letters should be sent to customers for collection of overdue debts.

d). Returns.i. Any goods returned by the customer should be checked for obvious

damage, and when accepted, a document should be raised. ii. All goods returned should be used to prepare appropriate credit notes.

Tests of ControlThese should be designed to check that the control procedures are being applied and that the objectives are being achieved.

i. Carry out sequence test checks on invoices, credit notes, dispatch notes and orders. Ensure that all items are included and that there are no omissions and duplications.

ii. Check the authorization for: Acceptance of the order. Dispatch of goods Raising of the invoice or credit note Pricing and discounts

iii. Seek evidence of the checking of the arithmetic accuracy of invoices, credit notes, sales tax, etc. This is often done by means of a stamp requiring several signatures on the invoice.

iv. Check dispatch notes and goods returned notes to ensure that they are referenced to invoices and credit notes.

v. Check that control account reconciliation have been performed and reviewed. Re perform the control by checking the reconciliation to the source documents.

In all cases, tests should be performed on sample basis.


PURCHASES SYSTEMControl ObjectivesFor all businesses purchases can be made on credit and thus the purchase cycle includes control objectives for payables.Control objective are as follows: To ensure that:-

i. Purchased goods/services are ordered under proper authorities and procedures.

ii. Purchased goods/services are only ordered as necessary for the proper conduct of the business operations and are ordered from suitable suppliers.

iii. Goods/services received are effectively inspected for the quality, quantity and other conditions.

iv. Invoices and related documentation are properly checked and approved as being valid before being entered as trade payables.

v. Only valid transactions relating to trade payables (suppliers invoices, credit notes and other adjustments) should be accurately recorded in the accounting records.

Control Procedures Over Purchases and Payables. As with the sales system, there are a number of controls that may be required in the purchase cycle due to the importance in this area.The following list of procedures is classified by the type of control: a) Orders

i. Requisition notes for purchases should be authorized. ii. All orders should be authorized by a responsible official whose authority

limits should be pre-defined. iii. Major items e.g. capital expenditure should be authorized by the board. iv. All orders should be recorded on official documents showing suppliers

names, quantities ordered and price. v. Copies of orders should be retained as a method of following up late

deliveries by suppliers. vi. Re-order levels and quantities should be pre-set.

b) Receipt of goods i. Goods inwards centers should be identified to deal with the receipt of all

goods. ii. All goods should be checked for quantity and quality. Goods received

notes should be raised for all goods accepted. iii. GRN’s should be checked against the purchase orders and procedures

should exist to notify the supplier of under or over-deliveries. GRN’s should be sequentially numbered and checked periodically for completeness.

c) Invoicing and Returns i. Purchase invoices received should be stamped and given a unique serial

number to ensure purchase invoices do not go astray. ii. Purchase invoices should be matched with GRN’s

iii. The invoice should be checked against the order and the GRN and casts should also be checked.

iv. The invoices should be signed and approved for payment by a responsible official independent of the ordering and receipt of goods functions.


v. Invoice sequential numbers should be checked against purchase daybook details.

vi. Invoices should be properly allocated to the general ledger account say by allocating expenditure codes.

vii. A record of goods returned should be kept and checked to the credit notes received from suppliers.

d) Accounts payable ledger and suppliers.i. An account payable ledger control account should be maintained and

regularly checked against balances in the ledger by an independent person. ii. Accounts payable ledger records should be kept by persons independent of

receiving goods, invoice authorization and payment routines. iii. Statements from suppliers should be checked against the purchase ledger

account. Tests of ControlThe following are appropriate tests of control for the documents in a purchase cycle: a) Purchase Order Test for:

i. Evidence of a sequence check. ii. Evidence of approval.

iii. Adherence to authority limits. b) Goods received note:Test for evidence of a sequence check. c) Goods Returned Note: Test for evidence of sequence check.d) Purchase Invoice: Test for:

i. Serial numbering. ii. Evidence of sequence check.

iii. Evidence of matching purchase invoices with GRN’s and purchase orders. iv. Evidence of checking casts and correct treatment of purchase tax. v. Approval of purchase invoice for further processing.

e) Credit Note Test for evidence of matching credit notes to goods returned notes. f) Payable ledger Test for evidence of authorization of adjustments to the ledger. g) Payable Ledger Control Test for:

i. Evidence of review of reconciliation of purchase ledger listing. ii. Evidence of authorization of adjustments to accounts payable ledger

control account.


TOPIC 9 9.0.0 VERIFICATION OF ASSETS AND LIABILITIESVerification is a process by which an auditor physically verifies assets and liabilities by trying to check for the following principles:-

1. Presentation and disclosure/recording process. 2. Ownership, rights and obligations. 3. Valuation. 4. Existence. 5. Authorization/Occurrence. 6. Completeness and measurement.

9.1.0 ASSETS1). Presentation and DisclosureAn auditor should check disclosure to ensure that an asset has been properly recorded or disclosed as fixed or current assets, free hold/lease hold etc.In addition the recording should obey the Generally Accepted Accounting Principles (GAAP) and statutory disclosures e.g. International Accounting Standards. 2). Ownership, Rights and ObligationsThis is verified with reference to title documents such as agreements, title deed, lease deeds contracts etc. Verification could also be by relying upon collaborative evidence from third parties like bankers.The auditor should vouch the benefits or revenues and expenses or costs associated with such an asset.Associate auditors should also be deployed to verify assets located far away. 3).ValuationThe auditor should ensure that the assets shown in the balance sheet is reasonable or shown at fair value. Or he should follow the conventional practice of cost less depreciation to get net book value.A Revaluation may be necessary of fixed Assets thus the auditor should ascertain whether the revalue figures are reasonable.

4). ExistenceThis calls for physical verification (Physical check) of the asset and as such must be done on a sample basis. Where items are material assets will be verified one by one and where immaterial, a sample of assets may be taken. 5). Authorisation and approvalThe auditor should check the authorization for acquisition of such assets from either the board or Annual General Meeting, although such authority may be delegated to other responsible officials, hence it will be necessary to read the minutes of the party that was giving the authority. 6). Completeness and MeasurementThe auditor should check that there is proper reconciliation of all the books kept in respect to particular assets and that proper calculations were carried out. 9.1.1 Verification of Motor Vehicles


1. The auditor of motor should check the authority for acquisition of motor vehicles usually, from the board of directors and ensure proper authorization.(authorization assurance principle)

2. Check the execution of authority to ascertain whether the purchase was as per the company’s policies or whether by tender or any other acceptable method.

3. Check the reasonableness of the price by comparing different quotations from different suppliers to ensure that the lowest quotations were awarded or accepted other factors being constant.

4. Check the value of the vehicle by taking the cost less depreciation and if the asset is technical, a valuer should be engaged to this effect.

5. With ownership the auditor should obtain the log book endorsed in favor of the client and check the following;

i. The make of the vehicle. ii. Capacity.

iii. Engine number. iv. The modes. v. Chassis number.

vi. Chassis number. All these must be agreed with the physical motor vehicle in all aspects and any differences investigated.

6. The auditor should obtain the road license and insurance certificate to ascertain whether they are in the names of the client. (ownership principle)

7. The auditor should check the recording of the motor vehicle in the motor vehicle registers, accounts and ledgers.

8. In case the vehicle is not physically available for inspection, the auditor should obtain a letter from its client to verify its location, ownership and existence (existence principle).

9.1.2 Verification of Land and Buildings

1. Examine the sample of available documents depending on national requirement and these may include documents of land title, land registry, certificates etc.

2. Inspect the director’s minute book to ensure that all documents of title tenancy agreement and leases are properly authorized.

3. Check the sample of entries in the tangible asset register and trace back to source documentation to ensure that they are properly stated at cost. (Principle of valuation)

4. Review company policies on depreciation and ensure that they are appropriate, in the line with the useful life of the building and ensure that land is not depreciated (Valuation and measurement principle)

5. Check the sample of calculations of depreciation and ensure that they are accurate and in line with company policies. (Measurement principle).

6. Review assets and establish a need of any write down for impairment in value. 7. If properties are let to third parties, inspect tenancy agreement and perform

analytical procedures on rental income. (look all any costs on the property) 8. Ensure that land and buildings are stated in accordance to International

Accounting Standard 16 at cost less Accumulated Depreciation. If valuation has been performed in the year of audit, the name of valuer and all his qualifications and the basis of valuation should be disclosed/given.


9. Physically inspect the sample of the assets.(existence) 10. Ensure that tangible asset register reconciles to the general ledger (completeness

and measurement). 9.1.3 Verification of Expenditure on InvestmentAn investment is held for wealth generation e.g. dividends earned from investments with shares, interests from investments and treasury bills etc. and capital growth.

1. Ascertain authority to acquire such expenditure either from the board. The Auditors should read the board minutes or the annual general meeting minutes and check for;

i. The nature of investments. ii. Number of investments.

iii. The issuing company. iv. Total capital commitments.

2. Check the Articles of Association to ascertain whether the investments are authorized to be undertaken.

3. The auditor should verify the title documents/ title deeds such as share certificates. This should be in the names of the client and in case these are kept by recognised agent the auditor should communicate with the agent to ascertain whether they are held free of charge.

4. In case the client has purchased a number of investments, the auditor should verify title documents in such a way that those verified are sealed to avoid duplication.

5. For existence, the auditor should not only request to review title documents but also should ensure that these documents are endorsed in the names of the client.

6. The auditor should prepare schedules of investments and reconcile the purchase price and market price to date.

7. In case some investments have been pledged as securities, the auditor should obtain authorization for that action from the annual general meeting or the board minutes.

8. The auditor should ensure that all investment should be categorized as listed or unlisted investments i.e. quoted or unquoted investments.

9. In case of listed investments the auditor should confirm their value by checking particular financial papers.

10. The auditor should ensure that no substantial fall of in value of investment has taken place since the last balance sheet date. In case it has taken place, the auditor should request Board of Directors and management to write off the difference of the book value and market value.

11. The auditor should check the recording of the investments in the investment ledger and ledger to ensure proper disclosure.

9.2.0 LIQUID ASSETSCash and BankCash and Bank are liquid Assets and this includes: notes and coins, Bank current Accounts Bank deposit Accounts. Major Objectives

1. All sums are received and subsequently accounted for 2. No payments are made which shouldn’t be made 3. All receipts and payments are promptly accurately recorded.

9.2.1 Verification of Cash at Bank


1. The auditor should either obtain a bank reconciliation statement or prepare one and trace entries in cash/book and those in the bank statement into a reconciled statement.

2. The auditor should ensure that there is no window dressing (i.e. presenting a good picture yet things are bad) which is manifested with an attempt to overstate the company’s’ liquid position. This could be through keeping the cash remittances and hence increase cash at bank and reduce debtors balance by an equivalent amount

3. He should obtain bank statement directly from the bank and check banking and withdrawals from this statement

4. He should trace items that are outstanding from the bank reconciliation statement of the bank statement and record items not cleared at the time of the audit..

5. He should verify all bankings to all pay-in-slips, and all withdrawals to counter folios of the cheque books and check the entries of the cash book.

6. The auditor should verify bank balance with respect to the standard bank letter, which should indicate:-

i. The bank balance at the end of the year. ii. Various accounts held by the bank.

iii. Any outstanding obligation by the client to the bank. 7. In case the client operates any foreign bank account, the auditor should

communicate with such bank and request for confirmation of the bank balance which should be converted into local currency using the rates of foreign exchange running at the balance of sheet date.

8. The auditor should note large deposits and withdrawals close to the end of the financial period to ascertain whether they are genuine or not.

9.2.2 Verification of Cash at Hand1. The auditor should pay a surprise visit to the client at the date of financial period,

and count cash at hand, then compare this with the cash book entry. 2. If the client operates several cash centres, the auditor should ensure that cash is

counted simultaneously to avoid shortages in one centre being made up with cash from another centre.

3. The process of cash counting should be done in the presence of cashiers who in case of shortage should given a certificate of shortages to the auditor.

4. The auditor should request the client not to keep a large amount of cash, since this may not only increase fraud but also make it difficult to count.

5. In case cash is kept in different branches, the auditor should pay a surprise visit and count the cash, where the auditor can’t visit the branches he should request the branch managers to deposit the cash into the bank and sent the deposit lists.

6. If some cash is held by agents or trustees, the auditor should request for documentary evidence so as to ascertain cash held by these parties. The auditor should also request management representation to highlight this.

7. An auditor should ensure that unbanked cheques are subsequently banked and check bank reconciliation statement to ensure that this has been done.

8. The auditor should ensure that the balances counted are recorded in the cash book and the relevant ledgers.

9.3.0 AUDIT OF STOCK IN TRADE (INVENTORY) Problems Encountered in Verifying Stock in Trade


1. In case of any misstatement of inventory balances there will be a direct effect on reported profit. The stock is the easiest asset to manipulate and thus manipulating profits from one accounting period to another. The auditor should put in a lot of effort to come up with right and correct stock figures.

2. Some stock is difficult for auditor to identify since there may be thousands of different lines of inventory or stock or items of very special nature. E.g. stock taking oil in tanks is dangerous.

3. The quantities of stock held at a given moment may be difficult to establish and it may not be possible to cease/stop inventory movements during inventory count.

4. Valuation may be difficult. Difficulties arise due to obsolescence of inventory and as a result the major value may be hard to establish.

5. The amount at which stock stated in accounts is always material in relation to accounts report and this calls for more work by the auditor in order to establish a fair value of stock.

6. Verification problems are associated with allocation of stock in particular or if stock is held at different points and has to be counted simultaneously to avoid omission of double counting (i.e. make sure there is no stock transfer at the time).

7. Stock may be overstated by the inclusion of stock sold but not dispatched or may include stock of non current assets e.g. furniture, fittings which are not traditional items to be included in stock in trade.

Duties of an Auditor as regards Stock in TradeThe auditor is not usually required to count stock but he should be present;

o Witness o Observe the exercise

It is duties as regards stock in trade;i. Duties before stocktaking.

ii. Duties during stock-taking. iii. Duties after stock-taking.

Duties Before Stock Taking1. He should review the working papers particularly the current audit file to

ascertain the previous year’s stock taking instructions so as to ensure that there are no loopholes whatsoever.

2. He should familiarise himself with the nature, volume, location of various items of stock especially items of high value identifying methods of counting the stock.

3. He should ascertain how much and the nature of stock held by the agents, subsidiary or associate companies.

4. He should review accounting systems relating to stock and identify the potential area of difficulty.

5. He should consider degree of co-operation expected from the internal audit i.e. areas they are prepared to cover for the external auditor.

6. He should ascertain whether expert advice is necessary to substantiate quantities of stock especially stock of high value.

7. He should evaluate adequacy of stock taking instructions and ensure that it covers all phases of stock taking procedures. It should be issued in good time and understood especially by those taking part in the stock taking exercise.

Duties of an Auditor during Stock Taking1. The auditor must observe and witness the way stocktaking is conducted so as to

gain assurance that the laid down policies are being followed.


2. He should select a number of items to be counted in particular high value stock and recount them to ascertain whether results obtained agrees with the contents of the sheets.

3. The auditor should note down items accounted in his current audit file so as to trace those in the final stock sheets, to ensure that they agree in all aspects.

4. If the auditor is not satisfied in the way in which stocktaking has been conducted, he should draw this to the attention of management and request a recount if necessary.

5. He should pay attention to stock of high value either individually or as a category of stock.

6. He should include photocopies or extracts of rough stock sheets in his current audit file or subsequent stock counts and to confirm these with the final stock sheets.

7. He should conclude whether the stock taking exercise has been properly conducted and whether it should be relied upon in determining of value of stock and existence of stock in trade.

Duties of an Auditor after Stock Taking1. He should consider whether stock taking instructions were completely followed

and in which case he should follow up the matter after stocktaking. 2. He should check final stock sheets and ensure that they are accurate and complete

by comparing them with rough stock sheets. 3. He should ensure that stock records have been adjusted and amounts of stock

physically counted didn’t differ from amounts stated. 4. He should check replies third parties regarding stock kept by them and at the same

time notify management where co-operation was lacking. 5. He should request for a letter of representation to give assurance of the values,

volume and condition of stock in trade held by client. Audit tests for Stock in Trade

1. Check the figures of stock in trade for the current financial periods and compare them with that of previous period, then investigate unfavourable variances.

2. Check current year’s working papers and review stock taking methods to ascertain whether they give assurance as regards to value and volume of stock in trade.

3. Check the standard costing statements to ascertain the value of stock from the point of view of the applications of variances.

4. Compute the stock turnover period for the current financial period and compare it with turnover period of previous financial periods and then investigate any variances.

9.4.0 AUDIT OF RECEIVABLES Control Objectives

i. All goods dispatched are invoiced. ii. Invoicing is at correct price and discount (if any).

iii. Goods are only dispatched on credit to approved customers. iv. Invoices are recorded and related to subsequent cash receipt. v. Credit notes are approved.

vi. The cashier doesn’t have to access cash received. This is relevant in order to curb down on teeming and lading.


(This is the offsetting of a debtor’s cash received against another debtor’s account to cover up a misappropriation of the first debtor’s cash received). Substantive procedures These are tests performed obtain audit evidence to detect material misstatement in the financial statement;a) Procedures under the control accounts.The auditor should obtain a list of receivables balance in the accounts receivable ledger and agree the total with the total in the control account. b) Year end balances

i. Inquires from management of the age of debts and possibility of future bad debts.

ii. Checking the authority and correspondences of bad debts written off. iii. Checking contras with the accounts payable ledger. Contras arise where a

company owes money to a third party and is owed by the same third party.

iv. Direct confirmation of receivable balances. v. Checking that the balances are made up of specific invoices relating to

recent transactions. vi. Review the individual accounts of major customers especially those that

appear irregular either by nature, or the size of the balances. c) Analytical procedures

i) a comparison of the receivable days ratio with the budgeted or prior years.Ratio = receivables * 365 Sales

ii) A comparison of the proportion of the debts in the current year to prior years. High or increasing incidents of all old debts may indicate either poor, deterioration of the economic condition or poor credit control.

d) Bad Debts The audit procedure to establish the appropriate allowances for bad debts include:-

o Considering company’s previous bad debts experience. o Evidence from confirmation of accounts receivables. o Age analysis of receivables.

e) Returns Inwards and Credit NotesThere should be strict internal control over returns inwards and credit notes to prevent fraudulent cancellation of company’s debt.f) Goods on sale or returns Goods on sale or returns should not be included In sales or receivables.g) Prepayments Evidence under prepayments will include;

o Considering clients normal accounting system for prepayments. o Obtaining the schedule of prepayments ensuring that it is cast correctly

and comparing it with prior year prepayments.

9.5.0 VERIFICATION OF LIABILITIES AND CAPITALVerification of Long Term Liabilities E.g. long term bank loan

1. He should check the authority to acquire such a loan from either Board or annual general meeting and ascertain;


The amount of the loan Interest payable Repayment of Interest and Principal.

2. The auditor should check the Articles of Association and Memorandum of Association to ascertain the whether the company has the power to borrow the amount of money borrowed.

3. He should obtain the loan agreement and check this for; The amount of the loan The nature of the loan Interest payable Repayment of principal

All these should agree with (I) above.4. The auditor should communicate directly with lenders and request

confirmation regarding amount outstanding, interest due and repayment pattern.

5. He should check the securities pledged to ensure that they adequately cover the loan.

6. In case the loan was obtained for a specific purpose, the auditor should ascertain whether it was used for such a purpose, in which case he will need to verify the asset acquired using the loan.

Verification of Share CapitalShare Capital is the capital acquired from the issue of shares. The steps involved in the verification of share capital include the following:-

1. For existing share capital, the auditor should verify this with reference to the previous closing balance, which should be equal to the current year’s balance unless there are any additions.

2. In case share issues were made the auditor should verify this with reference to company prospectus to determine ascertain number of shares issued and their value.

3. The auditor should obtain authorization of issue with reference to the AGM minutes to ensure that the issue was properly authorized.

4. He should obtain Articles of Association and Memorandum of Association and check for;

o The company’s’ authorized share capital. o The type of shares the company can issue.

All these should agree with contents of the prospectus.5. The auditor should verify any share capital raised with advertisements

made to check number of shares sold. 6. Auditor should obtain letters of allotment and compute the amount

received in respect of these shares and ensure that the allotment is approved by the board.

7. He should obtain share ledgers and registers and determine numbers of shares in the registers and cross check this allotment in the allotment letters.

8. He should agree dividends proposed unpaid to the Board minutes and ensure that the payments agree with total share capital issued.

9. The auditor should ensure that the brokers who participated in sale of shares sign a report regarding;


Number of shares sold. Value of shares sold. Preliminary issuing expenses.

10. The auditor should verify transfer shares with reference to The correspondence between buyers and sellers. Completed and stamped transfer forms. Genuine share certificates

Verification of Trade Creditors (Current Liabilities)1. The auditor should check the internal control system (ICS) regarding trade

creditors and ensure that it is strong enough to safe guard against possibilities of errors and fraud. He should ensure that statements for creditors are prepared and dispatched by officials different from those maintaining ledgers and effecting purchases.

2. He should prepare a schedule of creditors and compare entries in the schedules with those of the ledgers, goods received note (GRN) invoices, credit notes, dispatch notes all of which should agree in amount, date, nature of goods purchased (Ordinary purchases).

3. The auditor should select a sample of trade creditors for circularisation to confirm balances from such creditors so as to ascertain amount owed and the period for which it relates.

4. The auditor should compute the creditors turnover period and creditors turnover rate and compare it with the previous rates or periods and check for the variances.

5. He should reconcile a sample from ledger balances with the supplier’s statement. 6. He should check the recording in the creditor’s schedules and purchases ledgers.

Verification of Accruals Accruals are expenditures that have been incurred in current period but no payment has been made for it e.g. water bills, salaries, electricity bills, etc.Verification could be by;

i. Obtaining a schedule of Accruals ensuring that it is cast correctly and comparing it with prior year accruals.

ii. Scrutinising payments of such accruals in the current financial year to ascertain whether payments are not only authorized but also adjustments for them were made where necessary.

iii. Check the recording of accruals either under outstanding liabilities or in their relevant ledgers.


TOPIC 10 10.0.0 AUDIT OF LIMITED COMPANIES Before the auditor starts to audit limited companies he should examine the following items (books and documents). 10.1.0 Documents a) Memorandum of Association (MOA): - Every company must submit a Memorandum of Association to the registrar of companies before it can be registered as a limited company and thus be incorporated. This document highlights the activities, operations or businesses such a company intends to carry on. However, the auditor must examine the MOA to ascertain the following (which are very crucial to the audit)

i. To examine the object clause. A limited company should not carry out businesses other than those contained in the object clause of the MOA. Should any of the current business operations fall outside the scope of the object clause, these will be deemed to be null and void from the auditor’s point of view. Under such circumstances the auditor has the duty to mention such activities in his report to the company shareholders.

ii. The MOA is examined to ascertain the nature of accounts the company has to keep and the type of audit to be conducted on such accounts.

iii. It is examined to ascertain the issue of share capital and whether this is within the authorised share capital.

iv. To examine the capital clause of the company to ensure that if the capital structure has been changed, the procedure as laid down in the MOA is adhered to.

b) Articles of Association (AOA) This document together with the MOA must be submitted to the registrar of companies before the company’s registration is effected. The AOA usually contains the rules and regulations or guidelines regarding the way the company will be managed.The auditor should examine the company’s AOA for the following: -

i. Voting power of the shareholder. Usually a shareholder can vote in person or by proxy. One share is accorded one vote, thus the more shares one has, the more he can influence the policies of such a company.

ii. The company’s powers to borrow or lend on behalf of the company. iii. The appointment and remuneration of the company’s directors. iv. The appointment, remuneration, duties and powers of the auditor over and above

those specified in the Company’s Act. v. Annual General Meetings and Extra Ordinary General meeting and how these will

be called. vi. The issue of share capital and classes of shares. I.e. Ordinary shares and

preference shares. vii. The minimum amount of shares, which must be subscribed below which

allotment can be made. viii. The payment of underwriting and brokerage commission payable on issue of new

shares. ix. The number of calls that can be made on such shares. x. Circumstances under which any or all of the shares allotted can be forfeited.

xi. Types of dividends payable to different classes of shares e.g. interim and final dividends or bonus issue in lieu of cash dividends.

c) Prospectus


The prospectus is an invitation to the public to subscribe to the shares or debentures of a company. This is checked especially if it is the first audit. The auditor will check this document for: -

i. The company’s previous audited Profit and Loss account and the Balance Sheet for the last five years.

ii. The company’s current directors. iii. The company’s bankers, lawyers’, auditors, brokers, etc iv. The powers of the directors. v. The voting rights of the shareholders.

vi. The company’s current indebtness. vii. The company’s history i.e. how it came into being and who are its promoters.

viii. The company’s subsidiary and branches. 10.2.0 Statutory Books Minute Books These are required by the Company Act that they be kept at its registered office and in bound form. Usually a limited company will hold meetings either of shareholders, directors and other committees. Thus the main minute books are: - i) Shareholder’s minute book This book will contain discussions in all meetings held by the shareholders. These meetings may either be Annual General Meetings of shareholders or extra ordinary general meetings of shareholders. On his part, the auditor will examine the shareholders minute book to ascertain the following.

i. Adoption of annual accounts presented by directors in form of audited report.

ii. Approval of appropriation of net profits due to shareholders inform of dividends and retained earnings.

iii. Any other resolutions that may affect the account presented by the directors.

iv. Appointment of auditors. v. Removal of auditors.

vi. Remuneration of auditors. vii. Appointment of directors and managing agents of the company.

viii. Remuneration of directors and managing agents of the company. ix. Approval of loans to / by the company. x. Approval of purchase / sale of fixed assets.

xi. Approval of expansion or reduction in part or whole of the company’s branches of business.

ii) Director’s minute books The auditor has to examine the minute books to ascertain the following:

i. Adoption of annual accounts and audit report to shareholders. ii. Proposed dividends.

iii. Appointment of the company’s first directors. iv. Filling casual vacancies in the auditor’s office due to his death or

incapacitation. v. Fixing the remuneration and expenses of the company’s auditors.

vi. Approval of authorisation of capital expenditure e.g. to acquire of purchase fixed assets.

vii. Approval of directors’ remuneration and travelling allowances.


viii. Allotments of shares. ix. Allotment of debentures. x. Adoption of major contracts.

xi. Approval of major indebtedness e.g. approval of major loans, mortgages, hire purchase etc.

xii. Approval of major documents to which the company’s seal is to be affixed or has been affixed.

xiii. Appointment of bankers. xiv. Appointment of officers empowered to sign cheques and other bills on

behalf of the company. xv. Other matters to which the Article of Association of the company

demands a resolution from the company’s directors. iii) Committee minute books The board of directors usually may appoint different committees such as:-

o Finance committee. o Investigation committee o Disciplinary committee. o Budget committee. Etc

All of which are assigned specific task, which they have to fulfil and report back to the board of directors for their appropriate action. The auditor should however, insist that these minute books are signed by their respective chairman of such meetings so as to authenticate them and serve as reliable evidence of his opinion on any items contained therein. 10.3.0 Registers i) Register of ShareholdersThis register is usually kept by the registrar of the company concerned. It should contain names of the company’s shareholders and will contain the following: -

i. The name, occupation and present address of each shareholder. ii. Number and types of shares held or agreed to be considered as paid by

each shareholder. iii. The date on which a given shareholder was entered on the register. iv. The date on which a given shareholder ceased to be the company’s

shareholder. Number of working hours per day/ week during the year. ii) Register of Director’s Shareholding Every limited company is required by the Company Act to maintain a register of directors’ shareholdings, which should show:

i. Name ii. Amount

iii. Description of any shares etc. iii) Register of Contracts A Company may enter into contracts with such parties as promoters, brokers, vendors of property etc. For this reason the company should keep this register, which should show: -

i. The party contracted ii. The value of the contract.

iii. The reason for the contract. iv. The period of the contract etc.

Other documents the auditor should check before commencement of an audit of a limited company.


i. Certificate of incorporation ii. Certificate of commencement

iii. Certificate of existence of existence of Internal Control Systems. iv. List of responsible officers in the company and books kept by them and

their specimen signatures v. A previous year’s audit report.

Revision Question: State the main points which should be verified by the auditor in case of the following documents:-

i. Memorandum of Association. ii. Articles of Association.

iii. Prospectus iv. Minutes Books

TOPIC 11 11.0.0 AUDIT SAMPLING “Audit sampling is the application of compliance or substantive procedures to less than 100% of items within an account balance or class of transactions to enable the auditor obtain and evaluate the evidence of some characteristic of the balance or class of items to assist him/her form conclusions concerning those characteristic Internal Control Systems.” ISA 530. The reasons for Audit Sampling.

i. It is cheap to audit few items as compared to 100% check. ii. Less time consuming.

iii. Psychological reason. I.e. a complete check would bore the audit staff and hence becoming ineffective and material errors would be missed.

There are two approaches to audit sampling.a. Judgement Sampling b. Statistical Sampling

Judgement Sampling This means selecting a sample of an appropriate size on the basis of the auditor’s judgement of what is desirable i.e. it is a method where the auditor uses his own experience and knowledge of the client’s circumstances to select a sample without using any mathematical or statistical tools.The method is ideal under the following conditions:-

i. In deciding which tests to apply. ii. When deciding the degree of reliability to be placed on a given sample

iii. When deciding whether or not an item is material or not. iv. In deciding whether or not to accept the results of the sample.

Advantages of Judgement sampling i. Being a traditional method and having been used by auditors for quite some time,

it is easy to use and understand. ii. The auditor can use his professional judgement and experience in which case it

concurs with the process of auditing which is basically an exercise of professional judgement.

iii. No mechanical knowledge of statistics is required.


iv. It saves time on the part of the auditor as it avoids tedious computations, which are a characteristic of mathematical oriented scientific statistical sampling.

Disadvantages of Judgement Sampling. i. This method allows for personal bias in sample selection and as such may lead to

biased judgement. ii. It is wasteful in that it may lead to selection of samples which are too large as

compared to those obtained using scientific statistical sampling. iii. There may be no logic to the selection of the sample or its size. And as such

conclusions reached on the sample may not hold for the entire population. iv. No quantitative results are obtained. v. Conclusions reached on the evidence from samples are usually vague, since the

samples selected where not scientific in the first place. NB. Despite the above limitations, it is still a preferred method because it give a chance to the auditors to use professional judgement in auditing and minimises the use of mechanical conclusion.Statistical Sampling This is a method by which an auditor selects a sample using statistical tools involving mathematical manipulation in which a sample is tested to ascertain whether the tests (results) of the sample hold the population. This is ideal under the following conditions:-

i. Where the population is sufficiently large. ii. Where entries to be tested run the same risk of having error and frauds.

iii. Where the population is homogeneous in materiality, nature of items, and the time period.

iv. Where items are coded to facilitate random selection. v. Where entries can be stratified and in particular, where there is a definite

materiality level. Advantages of Statistical sampling

1. The method being scientific is defensible since conclusions reached may be objective.

2. It provides precise mathematical statements about the probabilities of being correct.

3. It saves time since it leads to selection of small samples as compared to judgement sampling.

4. It leads to uniformity of standards among different auditing firms and hence objective sample sizes for different firms.

5. It can be used by lower grade staff who due to lack of experience and knowledge may be unable to use judgement sampling.

Disadvantages of Statistical Sampling 1. As a technique, it is not always fully understood so false conclusions may be

drawn from the results. 2. The method is time consuming especially in large organisations as it involves a

lot of mathematics. 3. Being scientific it calls for trained audit assistants and as such increasing the

auditors training costs. ASSIGNMENT: Read and make notes on:

1. Sample selection-Characteristics. 2. Other sampling methods, i.e.


o Haphazard sampling o Simple random sampling o Stratified sampling o Cluster sampling o Systematic sampling o Multi stage sampling o Block sampling.

Revision Questions 1. a) Describe the sampling techniques applied in auditing.b) Why is statistical sampling sometimes preferred to judgmental sampling? 2 a) What is meant by audit sampling?b) State the characteristics of a good audit sample.c) List the factors, which are relevant in considering whether or not it is necessary to apply a sample. 3. a) What is meant by the term ‘audit sampling’?b) Why does the auditor need to adopt a sampling approach in the conduct of his audit work?c) Identify those situations where a sampling approach would not be appropriate.

TOPIC 1212.0.0 AUDITOR’S LIABILITY The auditor is considered and looked upon as a trustworthy individual. He performs audits and signs audit reports. These reports are the auditors’ opinions of the truth and fairness of the financial statements. This makes parties such as management, government tax authorities, financial institutions, insurance company, suppliers, the public etc to have faith and rely on such reports.For this reason, the auditor has responsibility to do his work independently with integrity and confidentiality. Like was in the case of: The London and General Bank (1895).It was held that, “He must be honest i.e. he must not certify what he does not believe to be true, and he must take reasonable care and skill before he believes what he certifies is true”. Hence an auditor who commits any wrong in the course of his duties is liable for the same. The liability of an auditor may arise under civil law or criminal law and he may be held liable by the client or third parties.Civil liabilityThis mainly arises due to the negligence of the auditor, violations of the provisions of the Company Act and non-compliance of the duties laid down as per the Company Act, auditing standards and guidelines etc. An auditor owes a duty of care and skill not only to the client but also to third parties. When an action is brought against him under civil law, he will be required to pay the losses suffered due to his negligence. In order to hold the auditor liable for negligence it must be proved that:-

i. He was negligent. ii. As a result of his negligence the client suffered loss.

iii. Loss was suffered by the person to whom the auditor owed a duty. Criminal liability


This arises out of an act consisting a crime e.g. when an auditor intentionally makes a false statement either in the balance sheet or any other document. The auditor is criminally liable for the following acts: -

o Fraudulently inducing persons to invest money. o Destroying altering, falsifying any documents. o Making false statements in any report, certificate, balance sheet etc

knowing it to be false. o Any action with intent to deceive others.

In order to hold the auditor criminally liable the following must be proved: - o That the statement made was false in material facts. o That the auditor wilfully made the false statement. o That the statement complained of has been made in any document

required to be made under any provision of the Company Act. 12.1.0 Auditors liability to third parties Third parties like tax authorities, bankers, government etc rely on the certificates, reports and statements of the auditor. Hence the auditor must exercise a fair, reasonable care and degree of skill in his audit work.Third parties can hold the auditor liable for damages in case of fraud or gross negligence, or if he has expressed an opinion with the intention to deceive.An auditor’s liability to third parties may arise in the following cases:

1. Where the auditor has been proved negligent and any third party has suffered a financial loss due to his negligence.

2. Where the auditor did not attach a disclaim to his report to the effect that the report was not intended to be relied upon by third parties.

3. Where the auditor was made fully aware that the third parties were going to rely on his report.

4. Where the third parties can prove that no other external factors influenced their decision making except the auditors' report.

5. Where the auditor owed a duty of care to third parties. 6. Where the auditor gives reference regarding his client’s credit worthiness.

NB: The auditor may be liable generally to the following third parties: - i. Any person to whom he owes duty of care e.g. debtors or creditors of his

client. ii. Persons who may rely on his work provided the auditor knew that those

persons would rely on his work e.g. bank managers, tax authorities etc. iii. Any person who is affected due to his audit report e.g. the employers of

his client. 12.2.0 Steps to minimize auditor’s liability.

1. By following ISA issued by professional bodies. 2. By agreeing the duties and responsibilities in an engagement letter. This should

specify the specific tasks to be undertaken and exclude specifically those that are not to be undertaken by the client and specify any limitations on the work to be done.

3. By defining in their report the precise work to undertaken, the work not undertaken and any limitations to the work. This is so that any third party will have knowledge of the responsibilities accepted by the auditor for the work done.

4. By stating in the engagement letter the purpose for which the report has been prepared and that the client may not use it for only other purpose.


5. By limiting or excluding liability by a term in the engagement letter or to third parties, by a disclaimer in a report.

6. By ensuring that an independent attitude is maintained at all times and objectivity is kept throughout his work.

Revision Questions 1) There is a growing practice for third parties to sue under the pretext that such third parties have incurred losses due to negligence by auditorsRequired:

a. To which parties might the auditor be liable? b. State the circumstances under which an auditor might be held liable to

third parties for negligence. c. Suggest how an audit firm might minimise its potential liabilities for

professional negligence. 2) Sebagala & sons bought shares of Shs 2billion six months ago in Uganda Clays which has since gone into liquidation. They intend to sue XYZ &Co Certified Public Accountants for the loss of Shs 2billion, which they are likely to suffer. XYZ &Co had audited the company the previous year and issued an unqualified report. Sebagala & sons claim that they relied on the audit report when they took the investment decision.

a. Do the auditors, xyz &co have any liability to Sebagala & sons? b. What circumstances must Sebagala & sons demonstrate if they have to

succeed against the auditors? c. State the measures xyz &co should undertake to minimise potential

liability for professional negligence.

TOPIC 13 13.0.0 AUDIT REPORT The audit report is the means by which the auditors express their opinion on the truth and fairness of the company’s financial statements for the benefit of the shareholders and other users.Before writing out the report, the auditor should review and assess the conclusions drawn from the audit evidence obtained as the basis for expression of an opinion on the financial statements. Basic elements of the Audit Report. The audit report includes the following basic elements usually in the following layout. a) TitleThe auditor’s report should have an appropriate title. b) AddresseeThe report is ordinarily addressed to the shareholders or the board of directors of the entity whose financial statements are being audited. c) Opening or Introductory paragraphThe auditors report should identify the financial statements of the entity that have been audited including the date of and period covered by the financial statements. The report should include a statement that financial statements are the responsibility of the entity’s management and a statement that the responsibility of the auditor is to express an opinion on the financial statements based on the audit. d) Scope paragraph (describing the nature of an audit)


The auditors report should describe the scope of the audit by stating that the audit was conducted in accordance with IAS and the Company Act e) Opinion paragraphThe auditors report should clearly state the auditors opinion as to whether the financial statements give a true and fair view in accordance with the financial reporting framework, where appropriate whether the financial statements comply with the statutory requirements. f) Date of the report.The auditor should date the report as of the completion date of the audit. g) Auditor’s addressThe auditor should indicate his address. h) Auditor’s signatureThe report should be signed in the name of the audit firm, the personal name of the auditor or both 13.1.0 Types of audit reports The various types of audit reports include:

o Unqualified report (good opinion) o Qualified report (bad opinion)

Unqualified Opinion / Report An unqualified opinion is an opinion in a report, which is positive and satisfactory. It is given to the effect that the accounts show a true and fair view of the financial statements. An auditor may issue an unqualified report in the following circumstances.

i. Where proper accounting records have been kept as per the requirement of the Company Act.

ii. Where adequate returns from the branches not visited have been received. iii. Where accounts agree with the accounting records and returns. iv. Where the auditor has received all information and explanations necessary

for the purpose of his audit. v. Where details of director’s emoluments and other benefits have been

correctly disclosed in the financial statements. vi. Where particulars of loans and other transactions in favour of directors

and others have been correctly disclosed in the financial statements. vii. Where information given in the directors’ report is consistent with the

accounts. Example of an unqualified report AUDITOR’S REPORT TO THE SHAREHOLDERS OF XYZ PLC We have audited the financial statements from pages…to… which have been prepared under the historical cost convention and the accounting policies set on page… Respective responsibilities of directors and auditorsAs described on page … the company’s directors are responsible for the preparation of financial statements. It is our responsibility to form an independent opinion, based on our audit, on those statements and to report our opinion to you. Basis of opinionWe conducted our auditing accordance with Auditing Standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the


financial statements, and of whether the accounting policies are appropriate to the company’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements. OpinionIn our opinion the financial statements give a true and fair view of the state of the company’s affairs as at 31 December 19.. and of its profit (loss) for the year then ended and have been properly prepared in accordance with the Company Act 1985. Registered auditors AddressDate Qualified Opinion / ReportA qualified opinion is an opinion in a report to the effect that the auditor is not satisfied with some aspects of the financial statements of the company and is either unable to express an opinion or can only form a negative opinion. In other words, it is a report stating that the financial statements do not show a true and fair view of the company’s state of affairs. An auditor may issue a qualified report in the following circumstances i.e. where:-

1. The financial statements have not been properly prepared in accordance with the Company Act

2. The financial statements do not give a true and fair view. 3. Proper accounting records have not been kept. 4. Proper returns adequate for their audit have not been received from branches not

visited by auditors. 5. Accounts do not agree with accounting records and returns. 6. The auditors have failed to obtain all the information and explanations considered

necessary for the purpose of audit. 7. The information given in the director’s report is not consistent with annual

accounts. Further classification of qualified reportsThe qualified opinion may be further subdivided as follows:Qualification Matrix

Nature/ circumstances giving rise to qualification

Matter material but not fundamental

Pervasive / fundamental to FS

Disagreement. The auditor disagrees with the accounting treatment or disclosure of a matter such as the non provison for doubtful debts

Except for…opinion. (Partial qualification. other parts show a true and fair view)

Adverse opinion.(Accounts do not show a true and fair view)

Uncertainty (limitation of scope) The scope of the audit work is limited. The auditor is unable to carry out procedures because of a lack of evidence e.g. a lack of accounting records that have been lost

Subject to…opinion.(partial qualification. Other parts show a true and fair view)

Disclaimer opinion (unable to form an opinion)


or destroyed, or a lack of adequate information and explanations from directors.

DisagreementThis means that the auditors do not agree with the accounting treatment or disclosure of some item in the accounts. UncertaintyThis is where there is a limitation in scope on the part of his audit work leading to the inability of the auditor to form an opinion. E.g. missing stock count at a branch. Except for…opinionThis is an opinion given where the auditor had disagreed over a matter material but not fundamental. E.g. Disagreement – except for: no provision for doubtful debts‘Except for failure to provide for doubtful debts, in our opinion the financial statements…give a true and fair view of the state of company affairs ‘ Adverse opinionThis is an opinion given where the auditor is unable to form an opinion as a result of disagreement over a matter that is fundamental. In this case, the auditor states that the financial statements do not portray a true and fair view of the financial position of the company. It is issued when:

o There is an omission of a material figure in the accounts. o Accounting principles are not complied with. o Failure to comply with the Company Act requirement.

Subject to …opinionThis is an opinion given when the auditor is faced with uncertainties over a matter that is material but not fundamental. E.g.Uncertainty – subject to no stock count at a branch.‘…Subject to the effects of any adjustments which might have been shown to be necessary had a physical count of branch stock been carried out, in our opinion, the financial statements… give a true and fair view of the state of company affairs…’ Disclaimer opinionThis is given where the auditor is faced with uncertainties over a matter that is fundamental and renders him unable to form an opinion. That is where the auditor has failed to form either a positive or negative opinion on the client’s records towards the ‘true and fair view’. It arises where:

o There is lack of co-operation between the client and the auditor. o There is inadequacy in the internal control systems. o There is lack of proper books of accounts required by the Company Act.

Qualities of a good report i. It should not be biased either against or in favour i.e not impartial.

ii. It must have a constructive criticism and not a reprimanding tone. iii. It must offer timely suggestions aimed at giving a company

solutions to problems highlighted in the report. iv. It must be clear and concise i.e. its conciseness should not be at the

expense of clarity. v. It must be forceful and not a compromise.


Revision Questions1a) Explain the meaning of each of the following terms, which are used in connection with audit reports.

i. Circumstances of uncertainties. ii. Circumstances of disagreement

iii. Disclaimer opinion iv. Except for opinion

b) Outline matters which should be included in an unqualified report. 2.

a. What are post balance sheet events? b. Why does an auditor need to be concerned with post balance sheet events? c. State and explain any five examples of adjusting post balance sheet

events? 3 a) State the prescribed circumstances in which an auditor under the Company Act is required to qualify his report.b) The report of the auditor on the annual accounts of a limited Company contains a ‘subject to...’qualification. Comment briefly on this form of opinion. 4a) Distinguish between a qualified and unqualified audit report.b) What are the FOUR principle categories of circumstances that give rise to a qualification? Give examples.
