AUDIT AUDIT PROCEDUREPROCEDURE

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Commonly used Audit Commonly used Audit ProceduresProcedures

Analytical ProceduresAnalytical Procedures Basic Audit Approaches -Basic Audit Approaches -

System Based Approach (SBA)System Based Approach (SBA) Direct Substantive Testing (DST)Direct Substantive Testing (DST)

Analytical Procedure - Analytical Procedure - DefinitionDefinition

Analytical Procedures consist of the Analytical Procedures consist of the evaluation of financial information in evaluation of financial information in audit, made by a study of plausible audit, made by a study of plausible relationships among both financial relationships among both financial and non-financial data. and non-financial data.

It involves analysis of significant It involves analysis of significant ratios and trends including the ratios and trends including the fluctuations that are inconsistent fluctuations that are inconsistent with other relevant data or which with other relevant data or which deviate from expectations.deviate from expectations.

Definition-Contd.Definition-Contd.

““Expectations”, in this context, refer to Expectations”, in this context, refer to the auditor’s expectations of what a the auditor’s expectations of what a figure in the accounts being audited figure in the accounts being audited should approximately be as worked out should approximately be as worked out from other relevant financial and non-from other relevant financial and non-financial information. financial information.

Their use is based on the assumption Their use is based on the assumption that there are relationships between that there are relationships between items in the accounts and that these items in the accounts and that these relationships may be expected to relationships may be expected to continue. continue.

Analytical Procedure: Analytical Procedure: ExamplesExamples The reasonableness of the figure of The reasonableness of the figure of

expenditure on expenditure on salariessalaries can be verified can be verified by multiplying the average number of by multiplying the average number of the employees in each grade with the the employees in each grade with the average salary for the grade.average salary for the grade.

The reasonableness of the The reasonableness of the interest on interest on General Provident Fund balance General Provident Fund balance can be can be verified by multiplying the average verified by multiplying the average balance in the General Provident Fund balance in the General Provident Fund with the prescribed rate of interest.with the prescribed rate of interest.

Commonly used analytical review Commonly used analytical review procedures procedures

comparisons involving a single comparisons involving a single componentcomponent

comparison across componentscomparison across components system analysissystem analysis predictive analysispredictive analysis regression analysis; andregression analysis; and business analysisbusiness analysis

Comparisons involving a single Comparisons involving a single componentcomponent

There are two types of comparisons.There are two types of comparisons. Comparison of the recorded value of a Comparison of the recorded value of a

component with its budgeted value. component with its budgeted value. Comparison of a component’s current value with Comparison of a component’s current value with

its value in previous years (trend analysis) its value in previous years (trend analysis) This procedure may be used at both the This procedure may be used at both the

planning and execution stages of audit. planning and execution stages of audit. In trend analysis, it is preferable to In trend analysis, it is preferable to

compare figures of a few previous years compare figures of a few previous years than just the immediately preceding than just the immediately preceding year in order to factor out any year in order to factor out any anomalies or aberrations specific to a anomalies or aberrations specific to a given year.given year.

Comparison across Comparison across componentscomponents

TThis involves analysis of the relationship his involves analysis of the relationship between more than one financial statement between more than one financial statement component. (also known as ratio analysis)component. (also known as ratio analysis)

Some examples are accounts receivable to Some examples are accounts receivable to turnover ratio, inventory-turnover ratio, gross-turnover ratio, inventory-turnover ratio, gross-margin ratio, etc. margin ratio, etc.

This procedure may be used at both the This procedure may be used at both the planning and execution stages of audit. planning and execution stages of audit.

More effective than single component More effective than single component comparisons because it considers the inter-comparisons because it considers the inter-relationships among different components and relationships among different components and provides assurance simultaneously for more provides assurance simultaneously for more than one component. than one component.

System analysisSystem analysis This involves identification of anomalous items This involves identification of anomalous items

within an account balance rather than a macro within an account balance rather than a macro level analysis of the balance itself. level analysis of the balance itself.

Individual entries in transaction listings are Individual entries in transaction listings are analysed to locate unusual entries or analysed to locate unusual entries or abnormalities. abnormalities.

This procedure can be effectively used during the This procedure can be effectively used during the execution stage. execution stage.

However, it is time consuming as it may involve However, it is time consuming as it may involve scrutiny of numerous transactions, if performed scrutiny of numerous transactions, if performed manually. manually.

For computerized data, use of appropriate For computerized data, use of appropriate auditing software could significantly aid the auditing software could significantly aid the adoption- of this procedure.adoption- of this procedure.

Predictive analysisPredictive analysis This involves creation of an expectation using not This involves creation of an expectation using not

just financial data but also operating or external just financial data but also operating or external data, independent of the accounting system. data, independent of the accounting system.

This can be used only where sufficient information This can be used only where sufficient information independent of the accounting system is available.independent of the accounting system is available.

Also known as an “independent test of Also known as an “independent test of reasonableness”.reasonableness”.

For example, volume of imports and import duty For example, volume of imports and import duty rate may be used to predict import duty revenue. rate may be used to predict import duty revenue.

The method is generally used in the execution The method is generally used in the execution stage.stage.

As it involves collection of reliable data from As it involves collection of reliable data from outside the accounting system, it is more time outside the accounting system, it is more time consuming than simpler analytical procedures.consuming than simpler analytical procedures.

Regression analysisRegression analysis This is a statistical technique that creates This is a statistical technique that creates

an equation to reveal how one variable is an equation to reveal how one variable is related to one or more other variables. related to one or more other variables.

Similar in principle to predictive analysis Similar in principle to predictive analysis but has added mathematical rigor and but has added mathematical rigor and objectivity. objectivity.

Generally used in the execution stage. Generally used in the execution stage. It requires understanding of the statistics It requires understanding of the statistics

of complex variables and is therefore not of complex variables and is therefore not “user-friendly” to the general auditor. “user-friendly” to the general auditor.

It also requires much time for application It also requires much time for application and testing and is therefore not in frequent and testing and is therefore not in frequent use.use.

Business analysis Business analysis TThis is a high (macro) level analysis of financial his is a high (macro) level analysis of financial

statements involving critical ratios related to statements involving critical ratios related to profitability, liquidity, financial stability, debt, etc. profitability, liquidity, financial stability, debt, etc.

It is a useful technique for identification of risk It is a useful technique for identification of risk areas during planning and audit completion stages areas during planning and audit completion stages and also for a better understanding of the entity and also for a better understanding of the entity and its operations.and its operations.

However, it provides no audit assurance and is not However, it provides no audit assurance and is not used in the execution stage. used in the execution stage.

It requires detailed knowledge of general business It requires detailed knowledge of general business relationships and trends and thus is a more useful relationships and trends and thus is a more useful tool for those experienced members of the audit tool for those experienced members of the audit team who can apply their cumulative knowledge of team who can apply their cumulative knowledge of the particular entity being audited.the particular entity being audited.

Steps involved in Steps involved in analytical reviewanalytical review

Develop an expectationDevelop an expectation Define significant differencesDefine significant differences Compare the actuals with the Compare the actuals with the

expectationexpectation Investigate any significant differences Investigate any significant differences

between actuals and expectationbetween actuals and expectation Document the first four steps and make Document the first four steps and make

an audit conclusion as to whether an audit conclusion as to whether assurance can be drawnassurance can be drawn

Analytical procedures can be used for Analytical procedures can be used for different purposes at different stages different purposes at different stages

of audit, viz.,of audit, viz., in planning the audit, to assist Audit by in planning the audit, to assist Audit by

pointing areas requiring examinationpointing areas requiring examination as substantive tests, in areas where analytical as substantive tests, in areas where analytical

procedures can be used to obtain evidential procedures can be used to obtain evidential matter regarding the accuracy of figuresmatter regarding the accuracy of figures

in reporting stage, to assist in the final stage in reporting stage, to assist in the final stage of the audit in assessing the conclusions Audit of the audit in assessing the conclusions Audit has reached and in evaluation of the overall has reached and in evaluation of the overall financial statement presentation by financial statement presentation by identifying odd or unusual figures in the final identifying odd or unusual figures in the final accounts.accounts.

Purposes of Analytical Review Purposes of Analytical Review ProcedureProcedure

Understand the entityUnderstand the entity Indicate risk areasIndicate risk areas Indicate possible misstatementIndicate possible misstatement Reduced detailed testReduced detailed test Obtain direct, positive audit Obtain direct, positive audit

assuranceassurance Assess going concernAssess going concern

Factors to ConsiderFactors to Consider

Objective of the analytical procedure Objective of the analytical procedure Nature of the entity Nature of the entity Knowledge gained from the previous Knowledge gained from the previous

auditaudit Availability Availability ReliabilityReliability RelevancyRelevancy SourceSource ComparabilityComparability

Basic Audit ApproachesBasic Audit Approaches

The Systems Based Approach The Systems Based Approach (SBA) (SBA)

The Direct Substantive Testing The Direct Substantive Testing (DST) Approach(DST) Approach

The SBA often leads to or fine-The SBA often leads to or fine-tunes the DSTtunes the DST

While SBA places emphasis on the While SBA places emphasis on the controls, DST is more concerned controls, DST is more concerned with evidence gathering.with evidence gathering.

Steps involved in SBASteps involved in SBA Identification and in-depth evaluation of relevant Identification and in-depth evaluation of relevant

key controls and assessment of the extent to key controls and assessment of the extent to which they can be relied uponwhich they can be relied upon

Testing of the operation of those key controls to Testing of the operation of those key controls to establish whether they have operated effectively establish whether they have operated effectively throughout the period under examinationthroughout the period under examination

Evaluation of the results of the tests of control to Evaluation of the results of the tests of control to establish whether the degree of reliance foreseen establish whether the degree of reliance foreseen can be taken from the examination of the controlscan be taken from the examination of the controls

Substantive testing of a number of transactions, Substantive testing of a number of transactions, account balances, etc. to determine whether the account balances, etc. to determine whether the financial statements of the entity are properly financial statements of the entity are properly presented, free from material misstatements and presented, free from material misstatements and the underlying transactions were regular.the underlying transactions were regular.

Steps involved in SBASteps involved in SBA (contd…)(contd…)

In addition, evidence gathering techniques In addition, evidence gathering techniques like review of documents, review of like review of documents, review of performance, physical observation or performance, physical observation or interviews will be used to test check interviews will be used to test check whether the key control function as whether the key control function as envisaged has been achieved. envisaged has been achieved.

Based on the results of the test check, the Based on the results of the test check, the auditor will arrive at a conclusion whether auditor will arrive at a conclusion whether the controls are reliable and the extent of the controls are reliable and the extent of their reliability. their reliability.

If necessary, the auditor may also indicate If necessary, the auditor may also indicate loopholes in the internal control systems loopholes in the internal control systems and suggest what additional controls could and suggest what additional controls could be introduced to remove such loopholes.be introduced to remove such loopholes.

Steps involved in DSTSteps involved in DST The approach is used when the audit The approach is used when the audit

objectives can be achieved without relying objectives can be achieved without relying on the systems in place in the auditee and on the systems in place in the auditee and without undertaking tests of control.without undertaking tests of control.

This methodology seek to provide This methodology seek to provide evidenceevidence as to the completeness, accuracy and as to the completeness, accuracy and validity of information in the accounting or validity of information in the accounting or financial statement. financial statement.

The testing involves The testing involves examination of samples examination of samples of transactions or account balances and is a of transactions or account balances and is a form of inductive reasoning where the form of inductive reasoning where the reasonableness of the aggregate results is reasonableness of the aggregate results is inferred from the evidence of reliability of inferred from the evidence of reliability of the individual details that have been tested.the individual details that have been tested.

Steps involved in DST Steps involved in DST (contd...)(contd...)

Identify the sub-system to be tested. Identify the sub-system to be tested. Identify the sub-audit objective to be tested Identify the sub-audit objective to be tested

for the selected sub-system. for the selected sub-system. Identify the Identify the

technique for gathering evidence. . Determine the sample size and perform test Determine the sample size and perform test

check using the identified technique for check using the identified technique for evidence gathering.evidence gathering.

Formulate conclusions on the fulfilment or Formulate conclusions on the fulfilment or otherwise of the sub-audit objective for the otherwise of the sub-audit objective for the selected sub-system.selected sub-system.

Levels of Substantive Levels of Substantive ProceduresProcedures

Substantive procedures can be performed Substantive procedures can be performed at one of three levels, depending on the at one of three levels, depending on the amount of assurance requiredamount of assurance required

Audit Decision Tree – tool to determine – tool to determine appropriate level of substantive appropriate level of substantive procedure requiredprocedure required

In decreasing order of assurance, they In decreasing order of assurance, they are –are – FocusedFocused Standard, andStandard, and MinimumMinimum

‘‘Focused’ Substantive Focused’ Substantive ProceduresProcedures

Circumstances in which applied

Substantive procedures

Performed if the audit team identifies a risk that could lead to potential material misstatement and where no reliance can be placed on mitigating controls to address the risk

•Testing high value and key items•Sample testing of representative transactions•Confirmation from third parties•Reliance on internal audit work•Analytical procedures are unlikely to be used

‘‘Standard’ Substantive Standard’ Substantive ProceduresProcedures

Circumstances in which applied

Audit Procedures

Performed if the audit team has not identified risks that could lead to material misstatement and no reliance is planned to be placed on controls

•Modelling / Comparative Type Analytical Procedures•Other Substantive Procedures

‘‘Minimum’ Substantive Minimum’ Substantive ProceduresProcedures

Circumstances in which applied

Audit Procedures

Performed if the audit team plans to take assurance from mitigating controls (where there are risks of material misstatement) or from other controls(where there are no risks of material misstatement)

•Comparison Type Analytical Procedures or•Other Substantive Procedures