Module 6: Preparation of an

audit
Course coordinator: Dr. Noor Rizvi
Learning objectives
After completing this chapter, you will learn:
• Steps involved in an audit
• Meaning and importance of audit plan
• Meaning and importance of audit programme
• Importance of evidence and working papers

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Introduction
In this chapter,
• The steps taken by the auditor while carrying out an audit will be dealt.
• Auditor uses various types of tools such as audit plan, audit programme
etc. for carrying out an audit.
• An audit plan is the first step of audit.
• Subsequently, the auditor makes an audit programme.
• While doing an audit the auditor has to collect evidences in support of
his opinion.

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Audit process
Appointment (Ethics)

Planning (Audit strategy)

Planning (Detailed audit plan)

Internal controls assessment & testing

Reduced/ Detailed substantive testing

Review (Finalization)

Reporting (Audit report)

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 Audit Ethics
Ethics is concerned with the behaviour, and trying to ensure that
auditors do the ‘right thing’…. Whatever it is!
Typically, ethics is about guidance, relying on professionalism of
auditors to apply this guidance in an appropriate manner when faced
with difficult situations. This is known as conceptual framework –
applying fundamental principles to each specific situation that arises,
rather than following the list of rules.
UK has adopted and altered the Ethical standards based on the IFAC
code*. ACCA adheres to the same.

*  International Federation of Accountants  5

 Audit Ethics
They are:
1. Integrity: Honesty, becoming a reliable and trustworthy person
2. Competence and due care: maintain professional knowledge and
skills
3. Confidentiality: Respect privacy of the client. Not use confidential
information for personal gains. (extra reading)
4. Professional behavior: Should respect law and regulations. Respect
the profession.
5. Objectivity: Auditor must be INDEPENDENT of their clients to ensure
greater trust between assurance provider and those reading the
report.

*  International Federation of Accountants  6

Ethical clearance from previous auditor
• Before accepting an appointment to act as an auditor, he/she is
required under the Ethical Code of Conduct to communicate with the
previous auditor to know whether there is any professional or other
reason for the proposed change of auditor.
• Normally, such communication takes place without difficulty but if one
is unsuccessful in getting previous auditor’s response, it may be
presumed that there no reason for not accepting the appointment.
• If he gets a negative response, then it is up to him to decide whether to
continue as an auditor or not.

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Letter Of Engagement
• IAS 210 requires an Engagement letter to be signed immediately after
appointment for each audit assignment.
• Letter Of Engagement has a standard format & content
• After the ethical clearance, auditor should send a letter of engagement
to the client.
• The letter of engagement sets out the agreement between the auditor
and the client as perceived by the auditor.
• Generally, letter of engagement is prepared by the auditor and sent to
the client, for which he often receives a written acknowledgement.

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Letter Of Engagement: Purpose
• Define the precise scope of duties and responsibilities
• Clarify to the client the distinction between the audit, accountancy or other
work.
• Emphasize to the client that audit may not necessarily discover fraud or error.
• Set out the basis of fees for work
• Decide the time frame for the audit
• Alert the client about its responsibilities for preparing the accounts
• Reference to the relevant audit standards to be followed, and other laws and
regulations that will guide the process.
• Explanation of the audit process and level of assurance that will be provided.

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Steps in conducting an audit
• Planning the audit
• Execution and controlling of audit
• The auditor’s report

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Audit Strategy
There is more than one way to perform the audit.
For each client, an appropriate strategy needs to be considered, which
covers the:
Scope
Timing
Direction of the process

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Planning the audit of financial statement (ISA 300*)
The auditor should plan his work in such a way that would enable him to
accomplish the audit in an efficient and timely manner. The need for planning an
audit is considered necessary with a view to:
• Devote proper time and attention to important areas of audit
• Identify problem areas and to take actions for resolving them
• Complete the audit covering all aspects
• Identify audit risks (*2)
• Select engagement team members with appropriate capabilities and
competence
• Direct and supervise the audit staff properly and to ensure proper
coordination.

*International Standards of Auditing

*2 the risk of material misstatement in the FS, which the auditor fails to detect (inherent risk, control risk, & detection risk) 12
Planning the audit of financial statement (ISA 300*)
AUDIT RISK = INHERENT RISK X CONTROL RISK X DETECTION RISK

Concept of materiality
A misstatement is material if it is important enough for those reading the FS to care
that it is wrong.
Types:
1. QUANTITATIVE MATERIALITY (measured by size) Risk equation
As a guide, errors are typically assessed as material if they are above:
0.5-1% of sales revenue
1-2% of total assets
5-10% of PBT (profit before tax)
2. QUALITATIVE MATERIALITY (measured by nature)
Some errors are important because of WHAT they are, instead of the size
E.g. Anything involving the directors (pay etc)
Anything involving fraud or illegal acts
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Audit plan
• An audit plan lays out the strategies to be followed to conduct an audit.
• It includes the nature, timing and extent of audit procedures to be
performed by the engagement team members.

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 Audit plan: Considerations
The auditor should consider the following matters before planning for an audit:
• Terms of Engagement and any Statutory Responsibilities
• Nature and Timing of Report or other Communications
• Accounting Policies followed by the Enterprise and Change in those Policies
• Effect of New Accounting or Auditing Requirements
• Identification of Significant Audit Areas
• Setting of Materiality Levels for Audit Purposes
• Degree of Reliance Expected to be placed on Accounting System and Internal
Control
• Nature and Extent of Audit Evidence
• Work of Internal Auditors
• Establishing and Coordinating Staffing Requirements 15
Audit programme
• An audit programme is a set of instructions (steps and procedures)
which are to be followed for proper execution of an audit.
• It contains the measures that are generally employed to determine what,
and how much evidence must be collected and evaluated.
• It also lays down the responsibilities for the whole audit team for
carrying out different tasks.
• It may be revised, if needed, in accordance with the prevailing
circumstances.
• Audit programme is documented in the Audit Working Papers, which are
the official record that contains the planning and execution of the audit
agreement.

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Audit programme: Advantages
• It helps in ensuring that all important areas are appropriately covered
during audit.
• It helps in distributing the work among the assistants in accordance with
the level of their competence and experience.
• It provides instructions to the audit staff and reduces scope for
misunderstanding.
• It helps in fixing the responsibility for the work done among the audit
staff as work done may be traced back to the individual staff member.
• It helps in assessing the progress of work by ascertaining what part of
audit work has been completed.
• On completion of an audit, it serves the purpose of audit record which
may be useful for future reference.
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Audit programme: Disadvantages
• Rigidity: Audit programme loses its flexibility as it can not be same for
different types of organisation. Each business has separate problems. So
a single/same audit programme can not be laid down for each type of
business.
• Reduces the Initiative of Efficient Staff: It kills the initiative of capable
persons. Assistant can not suggest any improvement in the plan.
• Audit Work becomes Mechanical: The Audit programme is mechanical
that it ignores many other aspects like internal control.
• New Areas may be Overlooked: With the passage of time new problems
arises during the audit may be over looked in the audit Programme.

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Audit programme: Remedies of
disadvantages
• The remedy in such situations is that audit programme should be
flexible must be always opens to changes and improvements.
• The audit staff should be encouraged to draw attention of the auditor to
any defects in the programme.
• The staff should be encouraged to explore fully unusual transaction and
do not get restricted with the audit programme.

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Audit evidence
The auditor has to obtain sufficient and appropriate evidence to
substantiate his opinion on the financial statements.
Essentials of good audit evidence
• Sufficient
• Reliable
• Relevant

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Audit documentation: Working papers
• Audit working papers are the documents prepared or obtained by the
auditors and retained by him in connection with the audit.
• Audit working papers are used to support the audit work done in order
to provide assurance that the audit was performed in accordance with
the relevant auditing standards.
• Usually retained for 5 years for safety.

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Working papers: Advantages
• Working papers helps in proper planning and performance of audit.
• Seniors can supervise the audit work performed by the juniors by
examining their working papers.
• It provide as evidence of the audit work performed to support the
auditor’s opinion.

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Working papers: Contents
• Name of the person who prepared it
• Date it was prepared
• Name of the person who reviewed it
• Date it was reviewed
• Name of the client
• Accounting year
• A file reference, and cross referencing to other pages
• Some explanation of the aim of the work that was done, how it was done
• Conclusion of the work
• If a sample was selected, which items were tested and how sample was
chosen.
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Internal Control
Why companies have internal control systems?
• To safeguard assets
• To try to reduce frauds and errors
• To increase business efficiency
• To reduce risk of breaching laws and regulations
• To improve accuracy of their accounting information

Why are external auditors interested in it?

• Because if controls appear to be good, assurance is gained that the FS are
materially correct- meaning that substantive testing can be reduced.
• Because a good control system helps in assessment of the strength and
integrity of a client’s management. 24
Substantive tests and tests of control
Even if control systems are assessed as very strong, auditors will do some
substantive testing.
Controls are never completely reliable because:
1. Staff makes mistakes
2. Controls are designed for normal events… unique transactions, may
bypass the system.

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It is expected that the audit work would be properly controlled and
satisfactorily accomplished so that quality of auditor’s work is
maintained at required professional level. Regarding execution and
controlling of audits, the following steps be taken to see that:

a) The auditors work is adequately supervised by a partner or an audit

manager, or a team leader depending on the activity/transactions
assigned to them.
b) Areas of potential errors, deviations from generally accepted
accounting principles and statutory non-compliances are identified.
c) Audit queries are either satisfactorily settled or are kept pending for
settlement at the time of finalization
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 Audit Finalisation
There are events that occur between year-end and FS signing. These are
known as ‘subsequent events’.

The auditors have a responsibility of review subsequent events before they

sign their audit report and may have to take action if they become aware of
it.

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Auditor’s report (Reporting)
• The auditor's report is a document containing the auditor's opinion of
whether a company's financial statements comply with GAAP.

• The audit report is important because banks, creditors, and regulators

require an audit of a company's financial statements.

• A clean audit report means a company followed accounting standards

while an unqualified report means there might be errors.

• An adverse report means that the financial statements might have

had discrepancies, misrepresentations, and did not adhere to GAAP.

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Auditor’s report: Components
The auditor's letter follows a standard format, as established by generally
accepted auditing standards (GAAS). A report usually consists of three
paragraphs.

1. The first paragraph states the responsibilities of the auditor and

directors.

2. The second paragraph contains the scope, stating that a set of

standard accounting practices was the guide.

3. The third paragraph contains the auditor's opinion.

An additional paragraph may inform the investor of the results of a

separate audit on another function of the entity.  30
Auditor’s report: Types
Clean or Unqualified Report
Means that the company's financial records are correct and conform to the
guidelines set out by GAAP.

Qualified Opinion
Means that although a company didn't follow the proper accounting
standards, the company didn't do anything wrong. For example, a mistake
might have been made in calculating operating expenses or profit. Auditors
typically state the specific reasons and areas where the issues are present
so that the company can fix them.

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Auditor’s report: Types
Adverse Opinion
Means that the auditor found that not only did the company not follow
accounting guidelines, but there were discrepancies in the financials. An
adverse opinion indicates that the auditor might have suspicions of material
misstatements or misrepresentations in the financial statements but does not
have enough evidence to clearly express that opinion. An adverse opinion is
the worst possible outcome for a company and can have a lasting impact and
legal ramifications if not corrected.

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THANK YOU

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Confidentiality clause
There are a small number of situations where auditors may decide, or
may be forced by law, to pass client information to third party. These
are:
1. If client is suspected of money laundering and illegal activities
2. If client is suspected of terrorism
3. If client is suspected of treason*
4. ACCA is investigating your work
5. A court order is obtained requiring disclosure

* attempting to overthrow the government 34