Audit procedures are carried out by the auditor in order to generate audit evidence. There are a number of audit testing procedures that may be available to the auditor. Whichprocedures are actually used will depend on the area that is being audited, and the evidence available to the auditor.
I. INSPECTION
This covers the physical review or examination of records, documents and tangible assets.
Inspection of tangible assets
Inspection of tangible assets that are recorded in the accounting records confirms existence but does not necessarily confirm rights or valuation.
Example
100 computers are recorded in list, so we will check these computers physical existence?
Confirmation that assets seen are recorded in accounting records gives evidence of completeness.
Example
Table A we saw Mr.Sok sit it is recorded in list of table or not?
Inspection of documentation or records
This is the examination of documents and records in paper or other forms. This procedure provides evidence of varying reliability. Inspection can provide evidence of existence.
Example
Expense ($500) for buying material recorded in system, so it has supporting document for expense or not?
II. OBSERVATION
This technique involves looking at a process or procedure being performed by others.
One example is the testing of controls over inventory counting or cash counting. This would include observation of controls in operation at warehouses during attendance at counts.
III. ENQUIRY
This involves seeking relevant information from persons inside or outside the enterprise.
An example in test of control is asking management for an explanation of the company’s policy for payment process. This would then be verified by reviewing documents completed during the process for evidence of completion of the process.
Inquiry alone does not provide sufficient audit evidence to detect a material misstatement at assertion level nor is it sufficient to test the operating effectiveness of controls.
IV. CONFIRMATION
Confirmation (a specific type of enquiry) concerns obtaining a representation directly from a third party.
For example, the auditor may seek direct confirmation of account receivables balance by writing to the customers.
The auditor may seek direct confirmation of account payables balance by writing to the suppliers.
For cash at bank, confirmation from bank of bank balances.
V. RECALCULATION
Checking the arithmetical accuracy of records or performing independent calculations. Recalculation This consists of checking the mathematical accuracy of documents or records.
Example
Payment of $20,000 has many supporting invoices from supplier, so we will check and sum each invoice from supplier.
VI. REPERFORMANCE
This is the auditor’s independent execution of procedures or controls that were originally performed as part of the entity’s internal control.
VII. ANALYTICAL PROCEDURE
Analytical procedures can be defined as the evaluation of financial information by studying the relationships between both financial data and non-financial data.
Analytical procedures include. They also include comparison of financial information with prior periods, budgets and forecasts and similar industries consideration of predictable relationships such as the relationship of purchases to sales, and payroll costs to the number of employees.
Practical Question
You are auditing the financial statements of Pumpkin Co for the year ended 31 March 20X9. Pumpkin Co is a chain of bakeries operating in 5 locations which customers purchase in cash.
The company has had a ‘challenging’ year, according to its directors, and is renegotiating its bank overdraft facility with its bank.
The statement of profit or loss for the year ended 31 March 20X8 is shown below together with the draft statement of profit or loss for the year ended 31 March 20X9.
Required
As part of your risk assessment procedures for the audit of Pumpkin Co, perform analytical procedures on the draft statement of profit or loss to identify possible risk areas requiring further audit work.
Answer
1. Profit for the year has increased by 87%
Pumpkin’s profit for the year has increased by 87% which appears with the revenue figure, which has only increased by 12% in comparison to the previous year.
This may indicate that revenue has been inflated or incorrect cut-off applied, especially given the fact that the directors of Pumpkin have described the year as ‘challenging’.
2. Revenue has increased overall by 12% but cost of sales has fallen by 12%
Revenue has increased overall by 12% but cost of sales has fallen by 12% – we would expect an increase in revenue to be matched by a corresponding increase in cost of sales.
Again this may indicate incorrect allocation of revenue in order for the bank to look favourably on the company and increase its overdraft facility. It could also indicate an error in the valuation of closing inventory.
3. The gross profit has increased by 28%
The gross profit has increased by 28% compared to the previous period. The audit will need to focus on this change which is significant, focusing on the revenue and costs of sales figures to establish the reasons for the increase.
4. Administration expenses have decreased by 16%
Administration expenses have fallen in comparison to the previous year (decrease of 16%) which is unusual given that revenue has increased by 12%. We would expect an increase in costs to be in line with the increase in the revenue figure. This could indicate that expenses may be understated through incorrect cut-off or incorrectly capitalising expenditure which should be written off to the statement of profit or loss for the year.
5. Selling and distribution costs which have fallen by 8%
A similar issue applies to selling and distribution costs which have fallen by 8% – they have not increased as expected in line with revenue. There could be legitimate reasons for the change but this area needs to be investigated further during the audit fieldwork stage.
6. Interest payable has increased by 2%
Interest payable has stayed in line with the previous year (increase of 2%). This figure can be verified easily during the audit fieldwork by inspecting bank statements and other relevant documentation from the bank.
Source :
1.BPP University, F8 and FAU
2.Kaplan, Inc., F8 and FAU