Auditing Notes:
Advantages of the proposed Audit Committee to any organizations:
1. By reviewing the financial statements, the Audit Committee improves the quality of financial
statements.
2. Reduces the opportunity for fraud because of the very existence of the Audit Committee.
3. Enables Non-Executive Directors to contribute positively in running the company by
exercising their independence.
4. The Audit Committee acts as a forum to which the Financial Director can refer matters of
concern he is unable to resolve through other means.
5. Recommends to the main board the nomination of statutory auditors for referring to the
Annual General Meeting.
6. Strengthens the position of the external auditors by providing a channel through which they
can raise matters of concern.
7. Strengthens the position of the internal audit department which reports to the audit committee
on matters pertaining to their work.
Disadvantages of the proposed Audit Committee:
1. The Executive Directors may not appreciate the role of the Audit Committee and may perceive
it as interfering with their work.
2. There may be problems in selecting suitable members with the required skills of the Audit
Committees.
3. Costs may increase because members of the Audit Committee are paid for being members.
Reasons why auditors are concerned with going concern:
Financial statements are usually prepared on the basis that the company is a going concern and
has the ability to continue to operate as a going concern and has no intention to significantly
scale down its operations.
In the event that a company is not a going concern, the financial statements are prepared on an
alternative basis the break up basis. Under this method non-current assets are reclassified as
current assets. If the wrong basis of preparing financial statements is used, then it means that the
financial statements are misstated.
The role of the statutory auditor is to obtain sufficient appropriate evidence on the ability of the
company to continue as a going concern. This is important because the auditor has to ensure that
the correct basis of preparation of financial statements has been used by the client company.
Examples financial indicators of going concern problems:
1. The company failing to pay its debts as they fall due.
2. Adverse financial rations.
3. Change from credit to cash-on-delivery transactions with suppliers.
4. Inability by the company to comply with terms of loan agreements.
5. Negative operating cash flows.
6. Fixed term borrowings approaching maturity without realistic prospects of renewal or
repayment.
Example of operating indicators of going concern problems:
1. The company having labor difficulties.
2. Intentions of Management to liquidate the company or cease operations.
3. Facing shortages of important supplies necessary for production.
4. The emergence of a highly successful competitor.
5. Loss of a major market share, key customers, license or major suppliers.
Ways that can be used to reduce audit fees:
o Putting the provision of audit services to tender so that those who wish to offer these services
submit bids.
o For group companies to reduce the number of audit firms and negotiate lower fees because of
the business given to the firm appointed.
o Introduce an internal audit department which will monitor the internal control enabling the
auditors to rely on the effectiveness of the controls and reduce the cost of audits.
o For groups of companies by selling off subsidiary companies leaving a simplified group
structure.
o Entering into a long term relationship with the audit firm considering ethical matters regarding
independence and familiarity.
Meaning of review engagements:
A review engagement is one that is entered into with a client where the practitioner performs
work that does not enable him give a reasonable assurance. This is done in situations where an
audit is not required by law and is a cost-effective alternative to an audit.
The amount of work that is conducted in a review engagement is less than that which is done in
an audit.
The objective of a review engagement is to enable the auditor to state whether anything has come
to their attention that causes them to believe the financial statements are not prepared, in all
material respects, in accordance with the applicable financial reporting framework.
Level of assurance in a review engagement:
The level of assurance that is gained from a review engagement is not as high as the one obtained
from an audit. This is because of the amount of work that is carried out in a review. Although the
procedures that are performed may be similar to those of an audit, much less work is performed
in a review compared to that of an audit.
How good internal control impact audit and the audit fee:
Internal controls are put in place by Management with the objective of helping in preventing and
detecting error and fraud.
If internal controls are operating as required, the risk that errors and fraud will not be detected or
prevented is reduced. In planning an audit, external auditors assess risk through gaining an
understanding of the entity and its environment in accordance with ISA 315. Among other
matters that the auditors gain an understanding of are the internal controls that exist in a client
company.
Once the auditors have recorded the internal controls systems of the client, they perform tests of
controls whose objective is to test the operating effectiveness of the controls throughout the
period under audit. If the results of the internal controls are satisfactory, the auditor will use a
combined approach and may reduce the extent of substantive tests. This means that the auditors
will do less detailed work and save on time and cost.
Tasks performed at interim audit stage:
A number of tasks can be done at the interim audit stage visit including the following:
o Most of the work that is carried out at the planning stage of the audit such as risk assessments
can be done at the interim audit stage.
o Tests of transactions that have taken place to the date of the interim audit visit can be done so
that only testing of the remaining period is done at the final audit stage.
o Limited substantive tests can also be performed at the interim audit stage although most of the
work on account balances can only be done at the final audit stage. For example, work on
additions and disposals of assets up to the date of the interim audit can be done at the interim
audit visits stage.
o Work on internal control and tests of controls to the period of the interim audit can be done at
that time. At the final audit stage only the remaining period will be covered.
Impact of interim audit work on the final audit:
The auditors will just perform tests on the remaining period for transactions and the balances at
the period end. Doing work at an interim audit stage helps the auditor reduce the amount of work
and time done and spent at the final audit stage.
Responsibilities of management and auditors regarding compliance with laws and
regulations
The primary responsibility for ensuring compliance with the relevant laws and regulations lies
with Management. Management must put effective systems in place to ensure compliance with
relevant laws and regulations. The Company Secretary or any Senior Manager with the required
legal knowledge and experience can be given the responsibility of ensuring any organization is in
compliance with all relevant laws and regulations.
Internal Auditors can also assist Management especially in detecting non-compliance with
relevant laws and regulations. It is not the auditor’s responsibility to prevent or detect non-
compliance with laws and regulations.
The auditor’s responsibility is to obtain reasonable assurance that the financial statements are
free from material misstatements, and in this respect, the auditor must take into account the legal
and regulatory framework within which an organization operates.
ISA 250 Consideration of laws and regulations in an audit of financial statements distinguishes
the auditor’s responsibilities in relation to compliance with two different categories of laws and
regulations:
o Those that have a direct effect on the determination of material amounts and disclosures in the
financial statements
o Those that do not have a direct effect on the determination of material amounts and
disclosures in the financial statements but where compliance may be fundamental to the
operating aspects, ability to continue in business, or to avoid material penalties
For the first category, the auditor’s responsibility is to obtain sufficient appropriate audit
evidence about compliance with those laws and regulations.
For the second category, the auditor’s responsibility is to undertake specified audit procedures to
help identify non-compliance with laws and regulations that may have a material effect on the
financial statements. These include inquiries of management and inspecting correspondence with
the relevant licensing or regulatory authorities.
Matters to consider when evaluating the level of competence of the Internal Audit
Department
The matters to consider include whether:
1. The Internal Audit Department is adequately resourced
2. The internal auditors are members of relevant professional bodies
3. The internal auditors have adequate technical training and proficiency
4. There are established policies for hiring and training, whether internal auditors possess the
required knowledge of financial reporting/the applicable financial reporting framework.
Audit documentation
Audit documentation is the record of audit procedures performed, relevant audit evidence
obtained and conclusions reached. The terms ‘working papers’ or ‘work papers’ are also
sometimes used.
ISA 230 Audit documentation states that the auditor shall prepare audit documentation on a
timely basis.
The form and content of working papers are affected by matters such as:
o The size and complexity of the entity
o The nature of the audit procedures to be performed
o The identified risks of material misstatement
o The significance of the audit evidence obtained
o The nature and extent of exceptions identified
o The need to document a conclusion or basis for a conclusion not readily determinable from the
documentation of the work performed or audit evidence obtained
o The audit methodology and tools used
Destruction of audit documentation
Destruction of audit documentation must be done properly, otherwise Mafuta Chartered
Accountants could be in breach of relevant laws and regulations. ISA 230 states that the auditor
must not delete or discard audit documentation of any nature before the end of its retention
period. The ISA also makes reference to the requirements of ISQC 1 Quality control for firms
that perform audits and reviews of financial statements and other assurance and related services
engagements regarding the retention of engagement documentation.
ISQC 1 requires that firms establish policies and procedures for the retention of engagement
documentation. It states that ‘the retention period for audit engagements ordinarily is no shorter
than five years from the date of the auditor’s report, or, if later, the date of the group auditor’s
report.’
It seems Mafuta Chartered Accountants has not established policies and procedures for the
retention of audit documentation. If this is true, the Partners must as a matter of urgency, develop
and implement policies and procedures for the retention of audit documentation. These must be
in line with the relevant laws and regulations. Professional Judgement is also needed before
finalizing the policies and procedures.
At the moment, the Zambia Institute of Chartered Accountants (ZiCA) could be consulted
regarding destruction of the audit documentation.
Corporate governance and Audit Committee’s written terms of reference
According to the Cadbury report (1992), corporate governance is defined as the system by which
companies are directed and controlled.
The following are the responsibilities which should be included in the written terms of
reference for the Audit Committee:
(i) To review the company’s risk management system.
(ii) To review the company’s internal control.
(iii) To monitor and review the effectiveness of the company’s internal audit function.
(iv)To monitor the integrity of the financial statements of the company and any formal
announcements relating to the company’s financial performance, reviewing significant financial
reporting judgements contained in them.
(v) To make recommendations to the board, for it to put to the shareholders for their approval in
general meeting, in relation to the appointment, reappointment and removal of the external
auditor and to approve the remuneration and terms of engagement of the external auditors.
(vi)To develop and implement policy on the engagement of the external auditor to supply non-
audit services.
Criteria used when evaluating the internal audit function
ISA 610 (Revised) Using the work of internal auditors gives the following criteria which the
external auditor must use when evaluating the internal audit function:
(i) The extent to which its objectivity is supported by its organizational status, relevant policies
and procedures
(ii) The level of competence of the function (iii) Whether the internal audit function applies a
systematic and disciplined approach (including quality control).
Audit procedures for wages paid in cash:
1. Arrange to attend the pay-out of wages to confirm that the official procedures are being
followed.
2. Before the wages are paid compare payroll with wage packets to ensure all employees have a
wage packet.
3. Confirm that no employee receives more than one wage packet by attending the pay-out.
4. Agree entries in the unclaimed wages book with the entries on the payroll.
5. Confirm that unclaimed wages are banked regularly by scrutinizing bank statements and
matching to amounts in the unclaimed wages book.
6. Review the pattern of unclaimed wages in unclaimed wages book; variations may indicate
failure to record.
Definition and recommended substantive procedures
Definition of substantive procedures
(f) Substantive procedures are audit procedures performed to detect material misstatements at
the assertion level.
They are generally of two types:
1. Substantive analytical procedures
2. Tests of detail of classes of transactions, account balances and disclosures.
Recommended substantive procedures
Obtain a bank reconciliation and a listing for the outstanding lodgments
Cast both the bank reconciliation and the listing for the outstanding lodgments to confirm
arithmetical accuracy
Match the lodgments in the cashbooks and bank statements in order to verify the completeness
of the listing for outstanding lodgments
Agree the
total for the listing for the outstanding lodgments to the amount shown on the bank reconciliation
Verify by inspecting paying-in slips that outstanding lodgments are paid in prior to the year-
end
Review bank statements after the reporting date to check whether the outstanding lodgments
have been credited.