Designing audit procedures
| by Graham Cosserat
01 Jan 1999
|A common examination requirement is to describe audit procedures for verifying an audit component such as stocks or purchases. Audit procedures, as the basis of audit programmes, are described by SAS 200 (ISA 300), Planning as a set of instructions to audit staff members. The audit programme also serves as a means of controlling and recording the performance of the audit although this function is not dealt with in this article. In describing the procedures it is normally appropriate to assume the audit is to be performed by inexperienced staff members.
Many candidates fail to provide the necessary degree of detail in describing audit procedures. For example, a required procedure is commonly described as �check that all invoices are recorded�. No explanation is provided as to how this �check� is to be performed. Although use of the word �check� is occasionally unavoidable, if you try to use a more descriptive phrase you are more likely to produce a satisfactory answer. We could rephrase the previous description as "trace invoices, whose numerical continuity has been checked, to the sales journal to ensure the completeness of recorded sales transactions". The staff member receiving such an instruction is much better informed as to what is required and why. The instruction can be further expanded by detailing the number of invoices to be traced, where the invoices are filed and how the sample is to be selected. For example, the instruction could be expanded as follows:
In practice this level of detail is unlikely to be expected in answering examination questions but you must use your judgement in the context of the specific requirements of the question.
For the benefit of candidates sitting the international stream paper reference is made to both UK and International auditing standards but, otherwise, UK terminology is used in this article.
The standard model
Almost all audit programmes follow a standard model. Even if asked to describe procedures instead of drawing up a full audit programme, it is useful to follow a model. The following represents a model that can be readily adapted to the audit of most transactions and balances:
Steps 5 and 6, the tests of details of transactions and balances, are the most important, and the rest of this article explains how to design such tests. To design such procedures you will need to:
The accounting system
In some questions the accounting system is described. This makes life easy for you in identifying the records and documents available to be used in drawing up the audit procedures. However, it is important that the procedures you describe are consistent with the system given in the question. If no system is described you should make a note of the typical documents and records likely to be available. For example, in a purchases system there are likely to be requisitions, purchase orders, goods inward notes, suppliers� invoices, suppliers� statements, purchase journal, bought ledger and its control account in the nominal ledger. In preparing for the examination you must obtain a thorough understanding of typical accounting systems for sales, purchases, cash payments and receipts and wages.
The ability to determine applicable audit objectives is crucial in answering such questions.
The key to developing audit objectives lies in:
If you are not already familiar with these their meaning will become clear when we relate assertions to objectives. An understanding of these assertions is vital if you are to be successful in the examination.
The assertion candidates find hardest to understand is that of completeness. It is also the assertion auditors find hardest to obtain sufficient audit evidence to support. You should make sure you understand its significance by carefully studying objectives listed below based on completeness. Occurrence can also be confusing in that it has a dual meaning. It refers to the fact that recorded transactions both took place and are legitimate transactions to the business. For example, the owner of a business might buy some flowers for his wife. The transaction occurred but it is not a business transaction. It should not, therefore, be recorded in the books as a purchase of the business.
SAS 400 (ISA 500), Audit Evidence states that, in drawing up audit procedures, auditors should make sure they cover all the relevant financial statement assertions.
Focus of procedures
Transactions classes are the individual economic exchanges of sales, purchases, cash receipts and payments and wages. Each class is recorded in a special purpose journal such as the sales journal. Each transaction is analysed into the separate account balances to which it is to be posted. Thus, a credit sales transaction is credited to sales and debited to debtors. Ledger accounts represent the cumulative effect of postings from different transactions classes. Thus, �debtors� are increased by sales transactions and reduced by cash receipts transactions. Auditing sales and cash receipts transactions will result in verifying the account balance �debtors�.
However, the account balance �debtors� is also made up of amounts owed by individual customers and audit procedures can be applied directly to verifying balances owed by each debtor. Although it is possible to verify debtors solely by tests of details of transactions or solely by tests of details of balances, evidence from different sources is more persuasive than evidence obtained from a single source. Evidence as to balances is, therefore, usually obtained by examining details of both transactions and balances.
Objectives Putting together our understanding of assertions and of the transactions classes relating to debtors we can draw up a list of audit objectives. See
Table 1 below.
You will not normally be required to produce such a chart in the examination but, in your exam preparation, you should devote one of your revision sessions to preparing such a chart for each major audit area. You will then be able to call it to mind readily in answering any question about audit procedures. The next step is in devising audit procedures for achieving each objective.
Types of evidence
Audit objectives are achieved through the use of appropriate procedures. SAS 400 (ISA 500), Audit Evidence identifies the following procedures for obtaining evidence:
You will need to be familiar with the use of each procedure and its applicability in achieving specific audit objectives.
Inspection of documents and records is the commonest audit procedure and can be used in achieving audit objectives relating to each of the assertions. However, the process of undertaking the inspection depends on which objective is being met.
In achieving objectives relating to existence or occurrence, the procedure is to vouch transactions, or items making up a balance, as recorded in the books to documentary evidence. Thus a sales transaction would be verified by vouching recorded sales transactions to supporting documents. Note that we are working from the records to the documents.
To verify completeness the direction of testing is the opposite. Given that documents represent evidence of transactions that occurred, we need to verify that all documents are recorded. This is sometimes referred to as tracing, as distinct from vouching. Note that we are working from the documents to the records.
Documents also provide evidence as to:
For these assertions the direction of testing is unimportant, the mere comparison of the records with documentary evidence being sufficient. An individual audit procedure may provide evidence as to more than one objective. Vouching and tracing records to and from documents also provides evidence as to measurement or valuation, rights and obligations and presentation and disclosure although, in
Table 2, we describe these as separate procedures.
Inspection of documents is also important in confirming cut-off. However, since we are concerned that transactions are entered in the correct period rather than not entered at all, we can verify completeness by vouching what is sometimes called the reverse population. With cut-off, this is the population of transactions recorded after balance sheet date. Vouching such transactions to goods inwards notes or despatch notes to confirm that they relate to transactions occurring after the year-end and not before, provides reasonably persuasive evidence as to the absence of cut-off error and the completeness of transactions recorded before balance sheet date.
Inspection of tangible assets is similar to the inspection of documents but provides more persuasive evidence. Again, for existence or occurrence, the audit procedure is to work from the records to the asset and, if the procedure is to provide evidence as to completeness, from the asset to the records.
Observation of procedures being performed such as counting at stocktake or distributing wages is more commonly applied in audit procedures testing controls than in substantive procedures.
Enquiry and confirmation involves making enquiry of knowledgeable persons. The response to the enquiry is not unlike documentary evidence and can provide evidence as to all assertions. However, this is subject to the form of the enquiry and the relationship of the knowledgeable person to the entity. If customers are asked to confirm their recorded balance, their reply provides evidence as to existence, valuation and rights. It is unlikely to provide evidence as to completeness because of a reluctance to admit to owing more. Such evidence is more commonly obtained in tests of balances than in tests of transactions.
Computation has two distinct elements. The more obvious one is the reperformance of computations performed by the entity. This can include additions on invoices, journals and ledgers and such calculations as are involved in determining accruals, prepayments and provisions. As such it provides reliable evidence as to valuation and measurement.
The second element is that of numerical continuity. This is often important in verifying completeness through ensuring the numerical sequence of pre-numbered documents recorded in a journal.
Table 2 illustrates the process of describing audit procedures by developing procedures for the test of details of sales transactions based on the objectives listed above. We shall assume a standard manual accounting system for sales involving pre-numbered despatch notes and sales invoices, a sales journal and sales ledger. In practice you will also need to consider the use of computer assisted audit techniques (CAATs) where there is no visible audit trail or where their use may be more efficient.
It should be noted that many of the procedures relate to the proper operation of double entry bookkeeping which ensures the reliability of the recording of accounting transactions. Candidates often forget the importance of such procedures in answering questions.
In every examination at least one core question will require a thorough understanding of the use of assertions in determining audit objectives and of the procedures for obtaining evidence in achieving the audit objectives. In describing the procedures care must be taken in ensuring that they are sufficiently comprehensive as to be followed by an inexperienced staff member. Practice in drawing up audit procedures through working past examination questions is necessary to ensure success in passing the Audit Framework paper.
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