ICAB TUTORIAL» Audit and Assurance

Forensic Audit: How and Why is Conducted

idbbisew — Sat, 02 Feb 2013 21:03:42 +0000

Forensic audit is needed or applied mainly in those situations which have legal consequences. In a forensic audit the auditor uses three types of skills to conduct an audit. Those skills are accounting skill, auditing skill and investigating skill and those skills assist in performing an audit examination into a company’s financial statements.

Forensic audit is one kind of investigation and unlike other audits it is accepted by court of law. Now-a-days it is a prominent issue and it has been used frequently because of the recent scandals of renowned organizations.

A forensic audit is an examination of an organization’s or an individual’s financial affairs which results in a report that is used for a court of law. This type of audit is required whenever law enactment officials need reliable data on a client’s economic activities. Its objective is to find out actual cash transaction, detecting accounting error and fraud, detailing total assets. It is mostly used as after-the-fact basis when organizations deduce that a fraud has occurred within their organization. Forensic audit uses both accounting standards and auditing techniques combined with investigating approaches to detect fraud and probable problem areas for further investigation in future.

A forensic auditor’s job does not confined only to identify fraud but also to provide litigation support in a court of law whether his findings result in a legal actions. For example in case of NGOs, they gain huge amount of donation from various parties including national and international donors. There was an allegation by court against the local fund agent about corruption, it is a forensic audit.

Important!

Forensic auditing is conducted with the emphasis on following crucial issues

The potential susceptive motive and greater opportunity to commit fraud
Whether the committed fraud engaged conspiracy between several susceptive activities
Whether the evidence contained in the form of proper documentation
Doing unethical activity to destroy physical evidence
Influence on others to gain personal benefits

To sum up, forensic audit is a special type of audit engagement in order to detect and investigate every kind of fraud which requires multidimensional skills including accounting skills, auditing skills and relevant as well as a clear legal understandings.

Basic Principles of Auditing

idbbisew — Wed, 21 Nov 2012 16:12:00 +0000

Integrity, Objectivity and Independence: The auditor should be straightforward, truthful and sincere in his approach to his professional work. He must be fair and must not allow prejudice or bias to override his objectivity. He should maintain an impartial attitude and appear to be free of any interest which might be regarded.
Confidentiality: The auditor should maintain the confidentiality of information acquired from the entity in the course of his work and should not disclose any such financial information to a third party without specific authority. It is remarked that an auditor should keep his ears and eyes open but his mouth shut as sign of professionalism.
Skills and Competence: The audit should be performed and the report prepared with due professional care by persons who have adequate training, experience and competence. This can be acquired through a combination of general education, technical knowledge obtained through study and formal courses concluded by a qualifying examination recognized for this purpose and practical experience under proper supervision.
Work Performed by Others: When the auditor performs work with assistant and the auditor will continue to be accountable for forming and expressing his opinion on the financial statements. At the same time he is entitled to rely on work performed by others provided he exercises adequate skills and care and is not aware of any reason to believe that he should not have relied. The auditor should cautiously supervise and review work performed by assistants.
Documentation: The auditor should maintain proper documentation, which are much more important in providing evidence that the audit was carried out in accordance with the basic principles.
Planning: The auditor should make proper plan for audit work to conduct an effective audit in an efficient and timely manner. Plans should be based on knowledge of client’s business operation.
Audit Evidence: The auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive test procedure. It will enable the auditor to draw reasonable conclusions based on the financial statements prepared by the management.
Accounting Systems and Internal Control: The auditor should gain an appropriate understanding of the accounting systems and related internal controls. Auditor should study and evaluate the operation of those internal controls upon which he wishes to rely in determining the nature, timing and extent of other audit procedures.
Audit Conclusions and Reporting: The auditor should review and assess the conclusions drawn from the audit evidence obtained and from his knowledge of business of the entity as the basis for the expression of his opinion on the financial information.

How Statutory Audit is Executed

idbbisew — Tue, 20 Nov 2012 22:53:46 +0000

Statutory audit is an issue related to compliance of the legal requirement. In statutory audit auditors has to comment and make a reasonable assurance on the true and fair view of the financial statements of the entity prepared by the management. Statutory audit is usually done by the chartered accountancy firm and they are internal party of the respective entity. There are many types of audit available which is prescribed by the different statute like Income Tax Act and Companies Act. Therefore, chartered accountancy firm needs to conduct many audits as per requirement of the statute. Statutory audit is done when any legal compliance related issue arises. It is done by the statutory auditor who will be a chartered accountant firm appointed by the shareholders of a company. Statutory audit will carry important legal compliance implications for ensuring highest amount of true and fair view of audited financial statements prepared by the management of the company.

How Statutory Audit is Executed

Getting appointment from the Board of Directors and Board resolution copy
Getting no objection letter from previous audit firm
Filing audit firm’s no disqualification status to the respective company
Getting letter of engagement from the respective company
Assessment of internal control and understanding the business
Formulation of internal audit program action plan
Conduction audit as per Companies Act and international accounting standards and auditing standards
Preparing an opinion on financial statement prepared by the management of the company
Reporting to shareholders
Attending to Annual General Meeting (AGM)

Difference between Accounting and Auditing

idbbisew — Fri, 16 Nov 2012 18:12:35 +0000

Accounting is recording of all the day to day financial transactions in the books of accounts leading to preparation of financial statements. On the other hand, Auditing is the critical examination of the transactions recorded in the books of accounts and makes a reasonable assurance.
Accounting is concerned with finalization of accounts and ready to make financial statements. On the other hand, Auditing is concerned with establishment of reliability of financial statements by making a reasonable assurance by auditors.
The objective of accounting is to ascertain the trading results of financial transactions. But the objective of auditing is to certify the correctness of financial statements prepared by the management.
Accounting starts when book keeping ends. On the other hand, Auditing begins when accounting records.
Accounting involves various financial statements for example, balance sheet, income statement, cash flows statement. Whereas, auditing depends upon the agreement or upon the provisions of law adopted by the regulatory authority.
Accounting involves maintenance of books of accounts. And Auditing is more than maintenance of books of accounts.

Limitations of Audit

idbbisew — Fri, 16 Nov 2012 17:35:51 +0000

A key issue for accountants is that there are limitations to assurance services, and therefore there is always a risk involved that the wrong opinion may be given, there are some of assurance engagement risks as follows.

Limitations of audit includes

Testing is used-the auditors do not oversee the process of building the financial statements from start to finish.
Accounting systems on which assurance providers may place a degree of reliance also have inherent limitations.
Most audit evidence is persuasive rather than conclusive.
Assurance providers would not test every item in the subject matter.
Client’s staff members may collude in fraud that can then be deliberately hidden from the auditor or misrepresent matters to them for the same purpose.
Assurance providers rely on the responsible party and its staff provides correct information, which in some cases may be impossible to verity by other means.
Some items in the subject matter may be estimates and are therefore uncertain. It is impossible to conclude absolutely that judgemental estimates are correct.
Nature of the assurance report might itself be limiting, as every judgement and conclusion the assurance provider has drawn cannot be included in it.

Difference Between Internal Audit and External Audit

idbbisew — Mon, 12 Nov 2012 19:37:45 +0000

Internal Audit

The internal auditors’ are part of the organization. Their objectives are determined by professional standards, the board of directors, and top level management of the organization. Their primary clients are management and the board of directors.
The internal auditor’s scope of work is comprehensive and concerned with all aspects of the organization both financial and non financial and the internal auditors focus on future events as a result of their continuous review and evaluation.
Internal audit must be independent in fact and independent in nature from the audited activities.
Internal audit is related to all the aspects of the organization’s internal control system.
Internal audit covers all the financial transactions of the organization.
Internal audit may be conducted during the whole year, having specific objectives established in accordance with the level of audit risks identified for each separate entity.
The importance of risk for the planning of internal control activity is very high, the assessments of risk being combined with other types of information like financial and operational activities.
Internal audit takes into consideration for the following activities for example, pressure on management to meet objectives, asset size, and liquidity, transaction volume and effectiveness of the system of internal control.

External Audit

External auditors are not part of the organization, but are engaged by it. Their objectives are set primarily by the board of directors.
The primary objective of the external auditors is to provide an independent audit opinion on the basis of organization’s financial statements.
External audit is independent from its client, the organization, its independence being specific to liberal professional judgements of financial statements.
External audit is related to the internal control system only from the materiality perspective, which permits them to eliminate those errors that are not significant in relation to material misstatement, because they do not have influences over the financial results.
External audit covers only those financial operations that have a contribution at the financial results and the overall performance of the organization.
External audit is an activity that is conducted usually yearly basis, as per the statutory requirement it is done at the end of the year.
External audit uses the information for the determination of nature of audit procedures that should be performed in the auditing process taking into consideration only financial aspects.
External audit takes into consideration for the following activities for example, management’s operating and financial decisions, entity’s industry is declining with many business failures and management’s attitude toward financial reporting.

What is Substantive Procedure in Auditing

idbbisew — Wed, 07 Nov 2012 21:00:03 +0000

Substantive procedure is intended to create evidence that an auditor assembles to support the assertion that there are no material misstatements in regard to the completeness, validity, and accuracy of the financial records of an entity. Thus, substantive procedures are performed by an auditor to detect whether there are any material misstatements in accounting transactions. They are of two categories for example, analysis of particulars of transactions and balances and study of noteworthy ratios and trends together with the consequential inquiry of unusual fluctuation and items. It is the function of examining documentation indicating that a procedure was performed in case of Inquiring and observing the occurred financial transactions during the period of time.

By using Substantive procedures, the auditor is trying to obtain evidence as to the existence, completeness, measurement, rights, obligations occurrence, valuation and presentation and disclosure of transactions and balances. A substantive test looks at a figure in the financial statements and seeks how that figures and amount could be directly verified ignoring the existence of controls. Therefore, for a cash balance a substantive test would be looking at the bank certificate and reconciling this with the balance sheet figure.

Some common types of substantive procedures:

Bank reconciliation statement inspection
Observation of fixed assets schedule
Examine physical inventory in hand and on site
Analyse accounts receivable and customer invoices
Examine accounts payable supporting documents
Analytical analysis of assets, liabilities, revenue, and expenses

Performing analytical procedures, the auditors examine both financial data and non financial data for example, the number of employees. Before starting their analytical procedures, auditors estimate the expected value before calculating the actual value so that the expected results are estimated based on preliminary discussions with the clients.

What are the Three Components of Audit Risk

idbbisew — Fri, 19 Oct 2012 23:32:27 +0000

Audit risk is defined as the risk that the auditor expresses an inappropriate audit opinion at the time of rendering audit services when the financial statements are materially misstated. Audit risk is the risk that an auditor will fail to modify his or her opinion when the financial statements contain a material misstatement. The overall goal of an audit is to form and express an opinion, on whether the financial statements give a true and fair view based on presented financial statements prepared by management. Low audit risk is important because it is not possible for auditors to verify all transactions for the time being and they perform audit based on sampling. Auditors tend to focus on key risky issues for example, overstated revenues, and understated costs that may likely have error in the financial statements.

Components of Audit Risk

Inherent Risk: Inherent risk is the susceptibility of an assertion to a material misstatement assuming no internal control policies or procedures. Inherent risk implies that auditors should attempt to predict where errors are most likely and least likely in the financial statement segments. Inherent risk may be low and high depending on the nature of balances of accounts of the financial statements.

Control Risk: Control risk is the risk that a material misstatement that could occur in an assertion will not be prevented or detected by the entity’s internal controls. The internal control systems are designed and developed by the management as per their internal business policy. Therefore, it will not be totally prevented, or detected and corrected, on a timely basis by the entity’s internal control systems. Control risk will be low if effective tests of controls can be ensured. An actual assessed level of control risk is set for each assertion based on evidence about internal controls.

Detection Risk: Detection risk is the likelihood that an auditor will not detect a material misstatement in an assertion. Detection risk could be material misstatements with other types of opinion expressed by the auditor. High detection risk means that the auditor will fail to detect a material error. Intensive audit procedures would lower the detection risk.

What are the Three Pillars of Basel II

idbbisew — Thu, 11 Oct 2012 00:53:39 +0000

The Basel II has defined a structured framework comprising three pillars such as Pillar I, II and III. Pillar I sets out minimum capital requirements. Pillar II defines the process of supervisory review of a financial institution’s risk management framework. Pillar III determines market discipline through improved disclosure. Basel II capital accord is known for its three mutually reinforcing pillars, which are minimum capital requirement, supervisory review process and market discipline. In the approaches for calculation of capital for pillar 1 are stated. In this section, these three pillars and the approaches for calculation of capital will be discussed. Pillar 1 of Basel II is somehow present in the previous capital accord Basel I but Pillar 2 and Pillar 3 are novelty. In the Pillar 1 it has identified three risks whereas in the previous accord there were two risks. Operational Risk was introduced for the first time in Basel II.

The Three Pillars of Basel II

Pillar 1-Minimum Capital Requirements: In Pillar I, three kinds of risk such as credit risk, market risk and operational risk are considered to determine the minimum capital requirement. The definition of eligible regulatory capital remains the same as outlined in the 1988 Accord i.e., the ratio of capital to risk-weighted asset remains unchanged at 8%. This pillar is a quantitative one.

Pillar 2-Supervisory Review Process: Pillar II ensures that not only do banks have adequate capital to cover their risks, but also that they employ better risk management practices so as to minimize the risks. Supervisors will be expected to evaluate the board and management of banks, to look into strategic decisions and to evaluate portfolio diversification as well as the ability to react to future risks in a rapidly changing environment. In particular, issues of transparency, corporate governance and efficient markets can be considered as additional challenges in pillar II enforcement.

Pillar 3-Market Forces: Banking operations are becoming complex and difficult for supervisors to monitor and control. In this context, Basel Committee has recognized the importance of market discipline and has suggested implementing it by asking banks to make adequate disclosures. The potential audiences of these disclosures are supervisors, bank’s customers, rating agencies, depositors and investors. With frequent and material disclosures, outsiders can learn about the bank’s risks.

What is Audit Committee

idbbisew — Thu, 27 Sep 2012 18:35:22 +0000

The Audit Committee assists the members of the board directors in fulfilling its oversight duties and responsibilities. The audit committee usually consists of three members of the board of directors; all of them should be independent in accordance with applicable Securities and Exchange Commission (SEC) rules and listing standards and the company’s corporate governance guidelines. Each member of the audit committee should have a basic understanding of finance and accounting and be able to read and understand the company’s fundamental financial statements. At least one member of the audit committee must be financial expert in accordance with the rules and regulations of the SEC and related accounting and financial management expertise in accordance with the generally accepted accounting standards. Members of the audit committee typically must be independent of management, meaning they do not receive any compensatory fee, other than for service on the audit committee and they directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by the company. The audit committee establishes internal control system and corporate governance for the company.

Purposes of the audit committee: The audit committee’s primary purpose is to assist the Board of Directors in its oversight responsibilities to shareholders, specifically with respect to the integrity of the company’s financial statements, the company’s compliance with legal and regulatory requirements and the qualifications and independence of the independent auditor and internal auditing function, the performance of the company’s internal audit function and independent auditor, and monitor the integrity of the company’s internal controls over financial reporting.