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AUDITING

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Auditing

AAA’s Definition: Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.

My Definition: To examine and assure

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Auditing

2 broad categories of audits:

1. Internal Auditing (R&S focus)

2. External Auditing

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Internal Auditing

Who does it? Internal employees (outsource)

For whom? Management

What? employee adherence to company policies and procedures – efficiency and effectiveness

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Internal Auditing -Types

Information systems: review AIS controls to assess compliance with internal control policies/procedures & effectiveness in safeguarding assets

Operational/management: reviews company resources and operations – for efficiency, effectiveness, as planned

Compliance: ensure compliance with laws, rules, and regulations

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External Auditing (FS Audit)

Who does it? Independent, external auditors For whom? SEC, investors What?

Examination of a client’s FS for the purpose of deciding whether or not the FS are fairly presented according to GAAP.

Attest function: give an opinion on the fairness of the FS wrt GAAP applying GAAS. Reliability and integrity of accounting records

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5 Step Audit Process(for all audit types)

(1) Audit Planning: Establish audit objectives, identify risks, Audit program

(2) Collect audit evidence: interviews, examinations, recalculations, sampling

(3) Evaluate evidence: materiality(4) Arrive at an opinion –

FS: standard unqualified, unqualified with explanatory paragraph, qualified, adverse, disclaimer

(5) Communicate Audit ResultsFS: audit report

IDEA, ACL

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Auditing Around vs Through the Computer

THROUGH

AROUND

INPUT

OUTPUT

PROCESSING

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Auditing Around the Computer

Ignores the controls and computer processing - assumes accurate output = proper processing

Auditor examines, on a sample basis, inputs to the computer and corresponding outputs

Suitable only if the following conditions are met:1. computer processing is relatively simple

2. Audit trail is clearly visible

3. A substantial amount of up-to-date documentation exists about how the system works.

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Audit Trail in Computer-Based System Visibility of audit trail is diminished In relational database systems, foreign keys

that link related tables form an electronic audit trail.

Example:I/S Revenue

Sale invoice

Customer Table

Customer ID

Invoice No.

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Auditing Through the Computer Auditor follows the audit trail through the

internal computer operations; attempts to verify that the processing controls are functioning correctly

Directly tests the computer controls and verifies the accuracy of computer-based processing of input data.

Tests controls that, if functioning properly would prevent errors from occurring.

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Which approach is best?

Let’s look at the audit guidelines…..

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Auditing Standards

Statement on Auditing Standards (SAS) 94 “The Effect of Information Technology on the Auditor's Consideration of Internal Control in a Financial Statement Audit” Auditor’s must have sufficient understanding (and

document) of each of the 5 components of the IC when planning the audit (2C RIM)

Addresses the effects of IT on IC May need to design tests of controls in addition to

substantive tests (of balances)

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AUDIT BENEFITS OF THE IT ENVIRONMENT (SAS 94)

Consistent processing large volumes of transactions or data

Enhanced information timeliness, availability, and accuracy

Facilitation of the additional analysis of information Enhanced ability to monitor the performance of

activities, policies, and procedures Reduction in the risk that controls will be

circumvented, if IT system controls are effective

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RISKS OF THE IT ENVIRONMENT (SAS 94)

Incorrectly processing data or consistently processing inaccurate data

Unauthorized access to data that might be destroyed or improperly changed

Unauthorized changes to computer programs Failure to make necessary changes to computer programs Inappropriate manual intervention Potential loss of data

Increase in potential loss resulting from computer fraud relative to manual fraud (increase of 10X).

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Which is the best approach?

Auditing Through the computer

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Auditing Through the Computer

1. Testing Computer Programs Test data: exception data, compare

processed info to predetermined answers ITF (Integrated Test Facility): process

transaction to update dummy records (TEST DATA IN REAL SYSTEM!!!)

Parallel Simulation:live data in program written by auditor (COSTLY!!!)

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Auditing Through the Computer

2. Validate Computer Programs Test of program change control: make sure

IC procedures exists and are followed Program comparison:compare production

program with archived old version (trojan horse, salami)

Surprise audits and surprise use of programs: compare accounting application programs unexpectedly with authorized version

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Auditing Through the Computer

3. Review of systems software Operating systems software Utility programs that do basic

“housekeeping” chores such as sorting and copying

Program library software that controls and monitors storage of programs

Access control software that controls logical access to programs and data files

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Auditing Through the Computer

4. Continuous Auditing:

Audit tools installed within the IS Audit hooks Continuous and intermittent simulation Embedded audit modules Exception reporting SCARF Snapshot technique Transaction tagging

Match these terms

With their definitions

On the next slides

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Auditing Through the Computer

Embedded audit modules: Application subroutine that captures

data for audit purposes

Write to a special log file called SCARF (systems control audit review file)

Ex: transactions affecting inactive accounts, deviating from company policy, write-downs of asset values

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Auditing Through the Computer

audit hooks:

audit routine that flags suspicious transactions (real-time notification)

Exception reporting:

mechanisms that reject certain transactions that fall outside predefined specifications

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Auditing Through the Computer

Transaction taggingPlace a special identifier on transactions so that they

can be recorded as they pass through the IS.

EX: tag an employee’s transaction records, manually calculate & compare

Snapshot technique

audit modules record selected transactions before and after processing. Auditor reviews to make sure all processing steps performed properly.

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Auditing Through the Computer

Continuous and intermittent simulation (CIS)

- audit module in DBMS

- examines all transactions that update the DBMS. If a transaction has special audit significance, the audit module independently processes the data, records the results and compares them with the DBMS results. If discrepancies, written to an audit log for subsequent review OR may stop DBMS from executing the update process.

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Auditing With the Computer

Additional Computer-assisted techniques (CAATS) Help auditor complete audit General use software: productivity tools (Word,

Excel, project management, ACCESS, SQL)Automated workpaper softwareGeneralized audit software (GAS): software

designed for auditor• Read, manipulate client’s computer-based data • Independent evidence about the validity of transactions

and balances

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How do auditors put it all together?

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Risk-based Audit Approach

GOAL: Provide a clear understanding of the errors and irregularities that can occur and the related risks and exposures

1. Determine the threats (errors, irregularities)2. Identify the needed control procedures 3. Evaluate the control procedures4. Evaluate weaknesses to determine effect

on nature, timing, and extent of auditing procedures. Compensating Controls?

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Risk-based Audit Approach

Evaluate Control Procedures System review – are procedures in place?

EX: review docs, interviews Tests of controls = compliance testing – are

the controls in place and working as prescribed?

Ex: observe operations, check samples of input, verify use, trace transactions

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Audit Risk Model

Used in audit planning: AR = audit risk: likelihood that the FS

are materially misstated AR = IR x CR x DR

Auditor

Cannot

reduce

Auditor can control this

Assesses general

and application controls

applicable to each FS assertion;

Tests of controls =Compliance tests

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Audit Risk Model

IR = inherent risk: susceptibility of an account or class of transactions to material error

CR = control risk = likelihood that the IC control structure will fail to prevent/detect a material error

DR = detection risk = likelihood that the auditor’s procedures will not uncover material errors More auditing procedures = lower DR Inversely related to CR: if CR is high, then an

auditor sets DR low and performs more substantive tests (detail tests of transactions and account balances)

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Audit Risk Model

Example Assume controls over the revenue

cycle are not effective and cannot be relied upon. The auditor is worried about the correctness of the A/R balance. To lower detection risk, what would the auditor do?

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Audit Risk Model

Example Assume controls over the revenue cycle

are not effective and cannot be relied upon. The auditor is worried about the correctness of the A/R balance. To lower detection risk, what would the auditor do?

Increase substantive testing of the A/R balance – send out lots of confirmation letters to customers.

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Generalized Audit Software 2 main computer auditing software packages: ACL

(Audit Command Language) and IDEA (Interactive Data Extraction and Analysis).

In this class, we will be using IDEA to audit several different general ledger accounts and look for employee fraud.

 Clients: American Express, BDO Seidman, Grant Thorton, KPMG, McGladrey and Pullen LLP, PriceWaterhouseCoopers, FDIC, GAO, US Departments of Commerce, Education, Interior, Labor, Transportation, EPA, Treasury, Dow Chemical, Chicago Board of Trade, Exxon Company USA, Revlon

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General Functions ofComputer Audit Software– reformatting– file manipulation– calculation– data selection– data analysis– file processing– statistics– report generation– sampling

- data retrieval

- apply edit checks

- file operations (join, merge, sort)