BY: Prof. Syed Majid Ali

Govt. College of Commerce And Eco.

Compiled By: Sana Choudhry

Student of GCCE

Edited By: Syed Talha Ali

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CHAPTER NO. 1 DEFINITIONS OF AUDITING/ AUDIT: Definition given by International Auditing Guidelines:

�An audit is the independent examination of financial statements or related information of an entity, whether profit oriented or not, and irrespective of its size or legal form when such an examination is conducted with a view to express an opinion there-on.�

EXPLANATION:

1. The examination is independent. 2. Examination of the financial statements and related information of the organization. 3. The organization may be profit oriented or not. 4. Irrespective of size or legal form. 5. To express an opinion (in the form of a report which is addressed to the owner of the form).

Another comprehensive, modern definition of auditing is as follows:

�Auditing is the systematic process by which a competent, independent person, objectively obtains evidence regarding assertions about an entity for the purpose of forming an opinion and reporting on the degree to which the assertions confirm to the financial reporting framework.�

EXPLANATION:

1. It is a systemic process (a step-by-step process). 2. The auditor is a competent, independent person. 3. Obtains evidences regarding assertions about an entity. 4. Formation of opinion. 5. Reporting on the confirmation of assertions to a degree he is satisfied.

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NEED OF AUDIT/ PURPOSE OF AUDIT: The concept of Stewardship accounting is the basis of audit. These Stewardship concepts refer to the practice that when a person is trusted for some resources. He must account for it. For example, in case of companies, the owners of business appoint the managers and provide them funds, i.e. capital. The managers run the business with these funds. At the end of certain periods, usually one year, the managers present the report of their conduct of business in the form of financial statements. In order to establish the credibility of these financial statements, independent auditors examine them. Therefore, we see that an audit is needed because,

�There is separation of ownership from management and the reports of management are to be examined by independent persons for their truth and fairness.�

MAIN OBJECTS OF AUDIT/ ADVANTAGES OF AUDIT/ IMPORTANCE OF AUDIT: The main objects or benefits of auditing are:

1. DETECTION AND PREVENTION OF ERRORS AND FRAUDS: An error is an unintentional mistake, where as fraud means an intentional act by one or more persons among management, employees, or others that result in a misrepresentation of financial statements. During the audit, the errors are identified and are removed and the frauds are also discovered and their effects are disclosed.

2. EXPRESSION OF OPINION: I.S.A. Objectives And General Principles state that the objective of an audit of financial statements is to enable the auditor to express an opinion on the financial statements.

3. CREDIBILITY OF FINANCIAL STATEMENTS: Due to the concept of Stewardship, independent auditors examine the reports of management and the auditor�s report helps to establish the credibility of financial statements.

4. MORAL CHECK: An auditor always has a moral check on employees and management. When they know their work is going to be examined by an individual person, they will be more careful towards their performance.

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5. SUGGESTIONS FOR IMPROVEMENT OF SYSTEM: The auditor makes detailed review of the accounting and internal control systems. The weaknesses are identified. The auditor reports these weaknesses along with their suggestions to the management in a separate letter called the management letter. It has been seen that drastic improvements are made in the systems by the management on the recommendation of the auditors.

6. RAISING LOANS: Usually the banks and credit institutes require a copy of the audited accounts and auditor�s report. The accounts are used to assess the ability of the borrower to repay the interest along with principle. The auditor�s report establishes the confidence on the accounts.

7. SHAREHOLDER�S SATISFACTION: According to the concept of Stewardship accounting, the shareholders would like to see the performance results of the managers, to have an assurance about the fairness of these results. For this purpose, the independent auditors audit the financial statements.

8. TAX CASE SETTLEMENTS: The entities have to pay different types of taxes. The audited accounts provide the authorities with the satisfaction that the financial statements show the true picture of the business.

9. STATUTORY REQUIREMENTS: There are certain requirements for audit under the Companies Ordinance 1984 and Income Tax Ordinance. By having the accounts audited, these requirements are fulfilled.

10. WORKER�S SATISFACTION: Under the law, in certain companies, the workers can participate in the profits of the enterprise. Under Workers Profit Participation Act, the companies are also required to contribute to the welfare fund established by the government. In the presence of audit accounts, the workers should be satisfied that profit has been disclosed and appropriate contribution has been made for their welfare.

11. INSURANCE CLAIMS: In case of any problem, the entity can enforce its claims of insurance against losses. This becomes relatively easier in the presence of audited accounts.

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SCOPE OF AUDIT: Scope means the range of actions. It refers to the procedures that an auditor performs in order to achieve his objectives. This is an overall framework within which the auditor carries out his work. The scope of audit is as under:

1. STATUTORY REQUIREMENT: This is one of the most important factors. The auditor always determines the scope of an audit in accordance with the requirements of the laws of the state.

2. PROPER PLANNING: All the audit work should be properly planned and organized to cover all aspects of the entity relevant to the financial statements to be audited.

3. REASONABLE ASSURANCE: To form an expert opinion on the financial statements, the auditor must ensure himself whether information contained in the accounting records and other source data is sufficient for making the financial statements. In forming his opinion, he must also decide whether the relevant information is properly communicated in the financial statements.

4. PROPER COMMUNICATION OF INFORMATION: The auditor must determine whether the relevant information is properly communicated by:

a. Comparing the financial statements with accounting records and other source data to determine whether they summarize the transactions and events.

b. Considering the assertions that management has made for the completion of the financial statements. The auditor assess the consistent applications of accounting principles, the manners in which the information has been classified and disclosed.

5. PROPER EVIDENCE: In order to satisfy himself with respect to the reliability of the accounting records, the auditor must gather proper evidences.

6. EXTENSION OF WORK: If the auditor suspects any fraud or error in the statements, he must extend his work to the confirmation.

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7. RELIABILITY AND INTEGRITY OF INFORMATION: Auditors should review the reliability and integrity of financial information and the means used to identify, measure, classify, and report such information. Auditors should examine whether the financial records contain accurate, reliable, timely, complete, and useful information.

8. COMPLIANCE WITH POLICIES, PLANS, PROCEDURES, LAWS, AND REGULATIONS:

Management is responsible for establishing the system designed to ensure compliance with such requirements as policies, plans, procedures, and applicable laws and regulations. Auditors are responsible for determining whether the systems are adequate and effective and whether the activities audited are complying with the appropriate requirements.

9. SAFEGUARDING OF ASSETS: Auditors should review the means of safeguarding assets and verify the existence of such assets. Auditors should review the means used to safeguard assets from various types of losses such as those resulting from theft, fire, and improper or illegal activities. Auditors when verifying the existence of assets should use appropriate audit procedures.

10. ACCOMPLISHMENT OF ESTABLISHED OBJECTIVES AND GOALS: Management is responsible for establishing objectives and goals, developing and implementing control procedures, and accomplishing desired results. Auditors should ascertain whether such objectives and goals confirm with those of the organization and whether they are being met.

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CHAPTER NO. 2 QUALITIES ON AN AUDITOR: Like all good citizens and professionals, the auditor should be honest, ethical, and morally a good person. These are personal qualities that every person should possess, but to be successful, an auditor should possess certain desirable qualities. These qualities are briefed below:

1. PROFESSIONAL QUALIFICATION: The auditor should possess a complete professional qualification. Under Companies Ordinance, the auditor of a public limited company should be a Chartered Accountant.

2. PROFESSIONAL MEMBERSHIP: The auditor should be a member of a recognized professional body like ICAP � Institute of Chartered Accountants of Pakistan. A professional body has a code of ethics and rules that are responsible for the conduct of their members.

3. INDEPENDENCE: The auditor should be independent in fact and appearance. He should not associate himself with some particular group. There are certain restrictions in the Companies Ordinance to ensure the independence of the auditors.

4. PROFESSIONAL RESPONSIBILITIES: Code of professional conduct issued by AICPA � American Institute of Certified Public Accountants � states: �In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities.�

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5. PUBLIC INTEREST: The members, i.e., an auditor or public accountant should perform the responsibilities in the best interest of the public.

6. OBJECTIVITY: Objectivity is a state of mind. The auditor should be objective, i.e., he should not have any personal interest. He should be straightforward. The auditor should keep in mind the objectives that he has to achieve during his professional work.

7. CONFIDENTIALITY: During the work of audit, auditor comes across many important and sensitive information regarding his client�s work and systems. It is required that he should not disclose such information. He should maintain strict confidentiality with regard to such information.

8. TECHNICAL STANDARDS: Auditing is a profession where auditors rely heavily on their judgments. In performing the work, frequent differences may exist regarding the opinions of the auditors. To narrow down the choices available and to provide guidance regarding the best available choice, technical standards like International Standards on Auditing (ISA) and International Accounting Standards (IAS) have been developed. The auditor should carry out his work according to the prescribed standards.

9. COMPUTER KNOWLEDGE: These days nearly all big entities are computerized in their functions. Computers are being used even in small businesses. The auditor should have a good understanding of such systems and should use CAATs � Computer Assistance Audit Techniques.

10. PLANNING: ISA Planning requires that the auditor should properly plan his work. Auditing is a systematic process and requires proper planning. Planning provides assurance that audit is completed effectively within the given time frame work.

11. DUE CARE: The auditor should exercise due care during the performance of his professional work. He should use all his abilities to discharge his responsibilities effectively and efficiently.

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12. QUALITY OF WORK: ISA Quality Control for Audit Work states that the auditor should implement quality control procedures to increase and maintain the quality of professional services offered. These procedures should be implemented at all levels.

13. RELATED LAWS: The auditor should possess a good understanding of the laws that are related to his work. He should apply procedures to detect any material non-compliance and should evaluate their effects on financial statements and on the business concern.

14. SKILLS AND COMPETENCE: The auditor requires specialized skills and competence that are acquired through a combination of general education, technical knowledge obtained through study and formal courses concluded by a qualifying examination, and practical experience under proper supervision. In addition, the auditor requires a continuing awareness of developments including relevant international and national pronouncements on accounting and statutory requirements.

15. INTEGRITY: An auditor should be honest and sincere in his work. He occupies the position of faith with the clients. It is required that he should do justice to his work and profession.

RIGHTS/ POWERS OF AN AUDITOR: A sense of responsibility is one of the major requirements for a statutory auditor of a company to perform his duties. For this, the auditors have been assigned certain rights under the Companies Ordinance for performance of their duties effectively.

Section 255 of the Companies Ordinance describes the legal provision of the rights of an auditor as follows:

1. ACCESS TO RECORDS: Every auditor of a company has the right of access to the books, papers, and accounts of the company at all times, whether these records are kept at the registered office of the company or at any other place.

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2. RIGHT OF INFORMATION: Every auditor is entitled to require such information and explanation from the directors, and other officers of the company, which is required for the performance of their duties.

3. BRANCHES OF COMPANIES OUTSIDE THE COUNTRY: The auditor has the right of access to the copies, extracts, books and papers of the branched of the companies outside the country.

4. ATTENDENCE AT ANNUAL GENERAL MEETINDS: The auditor of an entity has been assigned the right to attend all the annual general meetings of the entity.

5. RIGHT TO RECEIVE NOTICE: Section 50 and Section 255 provide that the auditor is entitled to receive notice and any other communication relating to any general meeting of the company.

6. RIGHT OF REPRESENTATION: Section 253 and Section 255 provide that the auditor has a right of representation at the annual general meetings of the company.

DUTIES/ LIABILITIES OF AN AUDITOR: The duties of an auditor of a company under the Companies Ordinance and well-established auditing practice may be summarized as follows:

1. KNOWLEDGE OF DUTIES: The most important thing is that the auditor should have the complete knowledge of his duties under the related laws and auditing standards.

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2. AUDIT REPORT: Section 255 requires the auditors to make audit reports, to the members, on the accounts, books of accounts, and on every balance sheet and profit and loss account and on every other document that is a part of the financial statements.

3. INFORMATION AND EXPLANATION: It is the duty of the auditor to obtain all the information and explanation for the purpose of his audit work, as it is required to state these facts in his report.

4. BOOKS ON ACCOUNTS: Section 230 provides information about the books of accounts that should be maintained by the company. It is the duty of the auditor to check if proper books of accounts have been maintained or not.

5. APPLICATION OF I.A.S. : Section 234 requires that the listed companies should prepare their accounts as per the requirements of International Accounting Standards that have been notified for this purpose by S.E.C.P (Security and Exchange Commission of Pakistan). The auditor should see whether these requirements are fulfilled.

6. TRUE AND FAIR VIEW: The auditor is required to report on the truth and fairness of the financial statements, therefore, he should determine whether the accounts have been prepared in a way to show the true and fair view or not.

7. ACCOUNTING POLICY: The auditor should see whether the company has applied the accounting policies consistently. If there is a change in any accounting policy, the auditor is required to state about the change.

8. DETECTION OF FRAUDS: The auditor is not liable for any carefully laid scheme of frauds and he is not bound to be a detective. But once he doubts the occurrence of a fraud or he gets any evidence related to a fraud, he should probe the matter to the bottom and should satisfy himself regarding the matter.

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9. BREACH OF DUTY: The auditor should absorb that there is not a breach of duty on his part and that he has performed his work according to the high level of competent and ethical standards.

10. ADVICE TO THE MANAGEMENT: It is not the duty of the auditor to give advice to the directors or members of the company. Its not the auditor�s duty to suggest what they should do but for an improvement in the system, the auditor may indicate the weakness and may advice the management in a separate letter called the �Management Latter�.

DIFFERENCE BETWEEN BOOK KEEPING, ACCOUNTING AND AUDITING:

1. MEANING:

A. BOOK KEEPING: It is an art of recording business transactions.

B. ACCOUNTING: Accounting includes the maintenance of accounting records, applications of accounting policy and making of financial statements.

C. AUDITING: Auditing means the examination of financial and related information of an entity to express an opinion there on.

2. RESPONSIBILITY:

A. BOOK KEEPING: Book keeping is only the responsibility of recording the transactions under the supervision of senior members of the members of the accounting department.

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B. ACCOUNTING: Accounting is the responsibility to keep the records and prepare the financial statements.

C. AUDITING: Auditor�s responsibility is to examine the financial statements and express an opinion on them in the form of an �audit report�.

3. SCOPE:

A. BOOK KEEPING: It is a work of clerical nature. The senior members who are responsible for the job determine scope of book keeping.

B. ACCOUNTING: The scope of accounting work is determined by the management according to the circumstances and nature of the business.

C. AUDITING: The scope of auditing is determined by the legislation and international standards of auditing.

4. PREFERENCE OF WORK:

A. BOOK KEEPING: Book keeping is the first step of the accounting process.

B. ACCOUNTING: The accounting work proceeds the auditing. First the record is maintained, and then the audit is carried out.

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C. AUDITING: Auditing work is performed after the accounting work. In other words, auditing starts where accounting ends.

5. CODE OF ETHICS:

A. BOOK KEEPING: There is no code of ethics in case of book keeping.

B. ACCOUNTING: Accountants usually have no code of ethics to follow in their professional work, but professional accountants have a code of ethics to follow.

C. AUDITING: Auditors follow the code of ethics of the professional body of which they are members. Example, in Pakistan the auditors follow the code of ethics given by ICAP (Institute of Chartered Accountants of Pakistan).

6. LIABILITES:

A. BOOK KEEPING: The book keeper is liable to record the transactions according to the instructions provided.

B. ACCOUNTING: The liability of an accountant is determined by the terms of his service agreement with the management.

C. AUDITING: Liability of an auditor is determined under the related legislations.

7. APPOINTMENT:

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A. BOOK KEEPING: The book keeper is appointed by the management.

B. ACCOUNTING: The accountant is appointed by the management.

C. AUDITING: An auditor is appointed by the owners of the business, i.e., the shareholders.

8. REMOVAL:

A. BOOK KEEPING: The book keeper can be removed by the management.

B. ACCOUNTING: The accountant can be removed by the management according to the terms and conditions of employment.

C. AUDITING: In normal circumstances, an auditor cannot be removed before the expiry of his contract but in special cases, the members, in extra-ordinary general meetings, can remove the auditors with the consent of at least two-third majority.

9. QUALIFICATIONS:

A. BOOK KEEPING: There is no qualification specified for the book keeper.

B. ACCOUNTING: No qualification has been prescribed by the law for an accountant.

C. AUDITING:

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The auditor of a listed company must be a Chartered Accountant.

10. PURPOSE:

A. BOOK KEEPING: The purpose of book keeping is to record the business transactions initially.

B. ACCOUNTING: The purpose of accounting work is to show the financial position and the results of business operations.

C. AUDITING: The purpose of auditing is to record the fairness of the financial statements.

11. REPORTING:

A. BOOK KEEPING: The book keeper submits his reports to the senior members responsible for book keeping.

B. ACCOUNTING: The accountant submits his reports to the management.

C. AUDITING: The auditor submits his report to the owner (i.e., the shareholders) of the business.

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CHAPTER NO. 3

PRELIMINARIES OF AN AUDIT/ STEPS BEFORE COMMENCEMENT OF AN AUDIT: Auditing is a process that is to be completed step-by-step by the auditor. The auditor of a newly established limited company should carry out the following preliminary work before commencing the actual audit work:

1. APPOINTMENT: Chapter No. 2 of the Companies Ordinance, 1984, gives details about the procedure for the appointment of an auditor. When an auditor is informed of his appointment, he should confirm it from the minutes of the general meeting of the members. He should obtain a certified true copy of the resolution of the board of directors or shareholders and keep it in the permanent audit file. If an auditor is being appointed in place of a retiring auditor, he should see whether the requirements of the Companies Ordinance, 1984, have been compiled with.

2. CONSENT LETTER: When an auditor is offered an appointment and he decides to accept it, this fact should be communicated to the company through a consent letter.

3. ENGAGEMENT LETTER: It is in the best interest of the auditor and the client that the auditor should obtain an engagement letter from the client before commencement of the audit. The engagement letter should clearly set forth all important terms and conditions of the appointment and conduct of an audit. An engagement letter helps to avoid any misunderstanding between the client and the auditor.

4. DOCUMENT: A copy of the Memorandum and Articles of Association should be obtained and studied carefully.

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5. COMMUNICATION WITH THE RETIRING AUDITOR: The ISA Standards require an incoming auditor to communicate with the retiring auditor. The incoming auditor should inquire the retiring auditor about any reasons that would restrict him from accepting the proposed appointment. He should confirm that there were no ethical reasons for which the retiring auditor had to leave the job.

6. KNOWLEDGE OF THE BUSINESS: ISA Knowledge of the Business requires the auditors to gain an understanding of the business of the client to plan and perform the audit effectively. Such knowledge is particularly important at the planning stage, so that the auditor is able to design his audit procedures according to the specified nature of the business. Therefore, it is essential for the auditors to obtain information on his clients and their business.

7. LIMITATIONS OF SCOPE: The auditor should observe that there is no limitation on the scope of his work. ISA Auditor�s Report states that, �while accepting a new engagement, if the auditor considers that there is a limitation on scope then he will have to issue a disclaimer of opinion and should not accept such engagement. This scope can be extended but cannot be reduced. The scope of work will determine his planning and his responsibilities and liabilities.�

8. PRELIMINARY RISK ASSESSMENT: In the initial planning phase, the auditor should make a preliminary assessment of inherent risk and control risk. Inherent risk arises due to particular nature of an item and control risk due to the failure of the system of internal control to prevent or detect the material misstatements. Before commencement of the audit, he should make an overall assessment for the risks involved.

9. INTERNAL CONTROL SYSTEM: Internal Control System comprises of all the policies and procedures that are established by the management of an entity to achieve its specific objectives. The auditor should obtain a detailed understanding of the system of internal control at the initial planning stage. A successful internal control system is one that succeeds to complete the books of accounts in time and keep them ready for audit.

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10. OPENING BALANCES: An important issue in case of new audit engagements is the verification of opening balances. ISA Initial Engagement � Opening Balances states, �For initial audit engagement, the auditor should obtain sufficient appropriate audit evidence that:

a. The opening balances do not contain misstatements that materially effect the current period�s financial statements,

b. The past period�s closing balances have been brought forward properly, and, c. Appropriate accounting policies are consistently applied or changes in accounting policies have

been properly accounted for and disclosed.�

The auditor should follow the guidance provided in the ISA for dealing with the opening balances.

11. WORK OF ANOTHER AUDITOR: Some f the components, branches or subsidiaries of the entity may be audited by another auditor. The auditor should consider the level of involvement of the other auditor. He should follow the guidance of the other auditor. He should follow the guidance provided in �ISA Using The Work Of Another Auditor�.

12. QUALITY CONTROL: ISA Quality Control for Audit Work requires the auditor to implement quality control procedures at the firm level and on individual audits. The ISA further requires that an evaluation of prospective clients and a review of existing records should be conducted in making a decision to accept or retain a client. The firm�s independence and ability to serve should also be considered.

13. ANALYTICAL PROCEDURES: The ISA standards states, �Auditors should apply analytical procedures at the planning and overall review stages of an audit.� This will help the auditor to identify and pay more attention to the points that show significant fluctuations or deviations from part trends or future expectations. The ISA 520 Analytical Procedures deals with: a. The nature and purpose of analytical procedures, b. The application of analytical procedures � at the planning stage and at the overall review

stage, and, c. Investigating significant fluctuations.

14. RELATED PARTIES: ISA Related Parties defines such parties as, �Parties are considered to be related if one party has the ability to control the other party and exercise significant influence over the other party in making financial and operating decisions.�

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15. AUDIT MATERIALITY: ISA Standards 220.1 states, �Auditors should consider materiality and its relationship with audit risk when conducting an audit.� ISA Standards 220.2 states, �Auditors should plan and perform the audit so as to provide them with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatement and give a true and fair view.�

EXTERNAL AUDIT AND IT�S CLASSIFICATION:

External audit is an independent audit function that provided reasonable assurance that published audited financial reports are free from material misstatement and are in accordance with legislation and relevant accounting standards. Only auditors registered with an appropriate professional body can provide external audit services.

CLASSIFICATION OF EXTERNAL AUDIT: External audit may be classified as follows: 1. CONTINUOUS AUDIT:

A regular examination of books of accounts is done by visiting the client throughout the year. For audit purpose the auditor visits the client more than once in a year. The routine audit of all transactions is done almost up-to-date. This audit is conducted in the following cases: a. Where presentation of accounts is necessary in immediately after year ending. For example, in

case of banks and other financial institutions. b. Where monthly audited accounts are required throughout the year. c. When the internal control system is unsatisfactory. d. Where business is large and large volume of transactions are involved. A. ADVANTAGES:

1. As the books of accounts are checked at regular intervals, errors and frauds can be

easily and quickly discovered and rectified at an early stage. 2. The auditor can carry out his audit work more effectively and efficiently.

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3. It helps in preparing the interim accounts. 4. Quick presentation of accounts is possible. The audited accounts can be presented

at the AGM (Annual General Meeting) to the shareholder soon after the end of financial year.

5. The auditor can give valuable suggestions to his clients as he keeps himself in touch with the position of the business.

6. The frequent visits of an auditor lessen the chances of frauds and keep a moral check on the staff of the client and make them regular in keeping accounts up-to-date.

7. Chances of negligence of any important point are minimized. 8. Keeps the clients staff regular.

B. DISADVANTAGES:

1. The continuous audit opportunities to the dishonest staff for making alterations of figures in the books of accounts after the auditor has checked them. These errors and frauds cannot be detected without further rechecking, which is carried out rarely.

2. There is a possibility that the auditor may loss the thread of his work and in consequence thereof, some entries may pass unchecked in the books of accounts.

3. This type of audit is more expensive as the auditor makes several visits and performs detailed checking.

4. The frequent visits of auditor may cause inconvenience to the organizational staff, because the same set of books are used by the auditor and client�s staff.

5. Queries may remain unsolved due to interval in visits.

2. FINAL AUDIT/ BALANCE SHEET AUDIT/ PERIODICAL AUDIT/

COMPLETE AUDIT: A final audit is that which is carried out at the end of the accounting year when all the accounts have been closed and final accounts have been prepared. A. ADVANTAGES:

1. There is a rare chance of alteration of figures after checking. 2. The auditor can perform his work more effectively as he is in possession of the full

facts related to one-year accounts under consideration. 3. Thread of work is not likely to be lost as the audit is completed in one session.

B. DISADVANTAGES:

1. It is more expensive as it requires more audit staff to be debuted to different clients on the same date. Moreover, in case of shortage of staff, it is very difficult to complete the audit work of all clients.

2. It is more effective in case of small concerns but in case of large concerns, it takes more time to complete the audit and due to the reason, the accounts to the shareholders cannot be presented in time.

3. It is not possible to check each and every transaction in case of a big concern.

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3. INTERIM AUDIT: This type of audit is conducted when the management of an organization desires to know the trading results of the business in order to declare dividend during the financial year or when audited financial statements are required soon after the closing of a financial year. A. ADVANTAGES:

1. It helps to complete final audit quickly and saves time. 2. Errors and frauds can easily be discovered, 3. The staff of the client becomes more efficient.

B. DISADVANTAGES:

1. Figures can be altered easily. 2. The management of the concern has to bear additional expenses.

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CHAPTER NO. 4 AUDIT WORKING PAPERS: DEFINITION: ISA Documentation defines working papers as, �Documentation means the material (working papers) prepared by and for, or obtained and retained by the auditor, in connection with the performance of the audit. Working papers may be in the form of data stored on papers, films, electronic media or other media.� Statement of the Auditing Standards (SAS) issued by AICPA (American Institute of Certified Public Accountants) defines working papers as: �The record kept by the auditor of procedures applied, tests performed, the information obtained and conclusions reached in an engagement�. From the above definitions it can be concluded that working papers are the record of auditors about an audit. Working papers can be prepared by the auditor himself or can be obtained from the entity or third party. Further these can be in any form, that is, paper or computer readable form. IMPORTANCE OF AUDIT WORKING PAPERS/ PURPOSE OF AUDIT WORKING PAPERS/ NEED OF AUDIT WORKING PAPERS:

1. The auditor leaves the original documents, books of original entry and ledger accounts to the entity after completion of his work. In the absence of such original records the working papers assist him to support his professional opinion.

2. In case of any suit against the auditor for negligence, the auditor uses the working papers as a tool to

defend himself from such damage. In this way, the working papers serve important legal purposes.

3. The auditor, during an audit, prepares various types of schedules. These skillful preparation and inclusion in the working paper facilitates the auditor to prepare the audit report.

4. The working papers help the auditor in organizing and coordinating all phases of audit work. In fact, the

working papers provide a record of the work done and of the remaining work to be performed.

5. The working papers enable the auditor to supervise the work of the audit assistants. The auditor checks the work of each audit assistant in daily bases from the working papers that are systematically filed on the audit folder just after the completion of every audit assignment.

6. The working papers help in coordinating the audit work where different locations are involved. The financial

working papers are returned to the control locations for review at final report.

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7. The working papers provide a permanent report of the audit procedures used and the data examined. The auditor can refer this record as and when he needs.

8. Sources of data noted on the working papers and explanatory comments about unusual accounting system

will provide guidance for the new auditor on subsequent examinations.

9. The working test procedures and supplementary comments provide evidence that a proper evaluation of internal control was carried out by the auditor during the examination.

10. Senior auditors evaluate the performance of each audit assistant on the basis of working papers submitted

after completion of the assignment. In this way, the senior auditors check the completeness, clarity arrangement and cross-referencing regarding the work of the assistant.

11. The working papers help the audit assistant to learn the audit techniques.

12. These are very much useful for tax purposes.

TYPES OF WORKING PAPERS: Generally the audit working papers are classified into two types on the basis of time of use of information. These are as follows: CONTENTS OF WORKING PAPERS FILES:

1. PERMANENT AUDIT FILE: Permanent audit file contains that information which is long term in nature and is required in subsequent audit. The exact contents will depend on the nature of the business and size of the audit. This file is used by the auditor on every audit. Generally, the contents of the permanent audit file are:

A. RELEVANT LAWS: This section contains extracts of different laws that are applicable on the entity�s business. For example, in case of banks, this section will contain extracts of Banking Companies Ordinance, prudential regulations of State Bank of Pakistan and other laws related to default and recovery of loans.

B. INCORPORATION OF BUSINESS: In this section, important material relating to the incorporation of an entity, like memorandum of association, prospectus, and permission of the controller of capital issue.

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C. RULES AND REGULATIONS: This section contains information about the rules and regulations developed and implemented by the entity. This may include, for example, employees service rules, recruitment and wages policies, supplier�s pre-qualifications, etc.

D. ACCOUNTING SYSTEMS: This section contains extracts from the accounting manual of the entity. In case of absence of this type of normal details, major accounting applications will be documented in this system.

E. INTERNAL CONTROL SYSTEM: In this section, extracts from the procedures manual or details of the system of internal control over important areas of the business are included. There are many techniques to document the internal control system followed by the entity.

F. BUSINESS PROCESS AND WORK FLOWS: This section contains information about the nature of the business and production process or main revenue generating functions.

G. ADDRESSES: In this section, all the important contact details like address, phone numbers, fax numbers, e-mail addresses, for main locations of the business along with a description of work carried out at each place. These contact details are kept for key members of management and dealing persons and board of directors.

H. ORGANIZATION CHART: This section contains information about the organizational setup, line of authority and delegation of powers.

I. SPECIMEN DOCUMENTS In this section, specimens of the document used by the entity are filed. These may include different types of vouches, debit and credit notes, bills of exchange, gate inward notes, delivery challans, etc.

J. DOCUMENTS OF LONG TERM USE:

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This section contains all documents that are required for long term periods for the future audits like debenture agreements, lease agreements, trade licenses, royalty agreements, etc.

CONCLUSION: Many other documents can be placed in the file that the auditor will need at every audit. It is again emphasized that different firms of chartered accountants use different arrangements of their files. Secondly some information may be transferred from permanent file to current file or visa versa. It is important to note that the permanent file shall be updated with the new information.

2. CURRENT FILE: This file contains information about the audit matters that are primarily related with the current period under audit. The exact form and contents of this file depend on the nature and size of the business. ISA Documentation suggests process the following important contents of this file: 1. Evidence of audit planning process including audit program and any changes there in. 2. Evidence of auditors understanding of accounting and internal control systems.

3. Evidence of the inherent and control risk assessment and any revisions.

4. Evidence of auditor�s consideration of work on internal auditing and conclusions reached.

5. Working on transactions and balances.

6. Computed significant ratios and trends.

7. A record of nature, timing, and extent of audit procedure performed and the results of such

procedures.

8. Evidence that the work performed by assistant was reviewed.

9. An indication about the person who performed the procedure.

10. Details of procedures applied regarding components whose financial statements were audited by another auditor.

11. Copies of communication with other auditors, experts, and third parties.

12. Copies of letters concerning audit matters communicated to or discussed with the entity including

the terms of engagement and material weaknesses in the internal control.

13. Letters of presentation received from the entity.

14. Conclusions reached by the auditor concerning significant aspects of the audit.

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15. Copies of the minutes of the meetings.

16. Copies of the financial statements and auditor�s report.

OWNERSHIP AND SAFE CUSTODY OF THE WORKING PAPERS: ISA Documentation states, �Working papers are the property of the auditor, although portions of or extracts from the working papers may be made available to the entity at the discretion of the auditor, they are not a substitute for the entity�s accounting records.� This ISA further requires that the auditor should adopt appropriate procedures for maintaining the confidentiality and safe custody of the working papers and for retaining them for a period sufficient to meet the needs of the practice and in accordance with legal and professional requirements of record retention. LEGAL CASE: In R.E. Sockockinsky vs. Grahams and Company 1935, England, it was held, �And auditors� have a right to retain working papers even after the payment of the audit fee. The books of accounts are the property of the client and the auditor cannot retain them.� From the above discussion, we come to know that the auditor prepares the working papers. As they contain detailed information of the entity, at times an entity may request the auditor for extracts of the working papers. It is the discretion of the auditor to provide any such extracts or not. The permission of the extraction does not affect the auditor�s ownership of the working papers. The auditors should also preserve the working papers for a period sufficient to meet the professional requirements.

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CHAPTER NO. 5 INTERNAL CONTROL: DEFINITION: ISA Risk Assignment and Internal Control provides a definition of internal control system which is as follows: �Internal control system means all the policies and procedures adopted by the management of an entity to assist achieving management objectives and ensuring as far as possible the orderly and efficient conduct of business including adherence to management policies, the safeguarding of assets, the prevention and detection of frauds and errors, the accuracy and completeness of the records, and the timely preparation of reliable financial information.� EXPLANATION:

a. POLICIES AND PROCEDURES: It shows that internal control system refers to a collection of policies and procedures. The individual policy or procedure is known as internal control and together they form internal control system.

b. ADOPTED BY MANAGEMENT: This shows that the responsibility for the establishment of policies and procedures is that of the management. The management should design and implement the control system considering the nature and type of the business.

c. ACHIEVEMENT OF MANAGEMENT�S OBJECTIVES: The basic purpose of the establishment of the internal control system is to achieve the objectives set by the higher management. The most important objectives of management are as follows: 1. Orderly and efficient conduct of the business. 2. Adherence with management policies. 3. Safeguarding of assets. 4. The prevention and detection of frauds and errors. 5. The correctness and completeness of accounting records. 6. Timely preparation of reliable financial information.

From the above definition, it is very much clear that internal control system comprises of policies and procedures that are adopted by the management of an organization to achieve its specific objectives that mainly include safeguarding of assets and preparation of reliable information.

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OBJECTIVES OF INTERNAL CONTROL: According to the ISA Risk Assignment and Internal Control the main objectives in internal control system in relation with an accounting system are as follows:

1. AUTHORIZATION FOR TRANSACTIONS: The control system should ensure that all the transactions are executed with the authorization of the management. There may be general or specific approval for particular transaction. The system should provide for further authorization by appropriate level of management.

2. RECORDING OF TRANSACTIONS: All the transactions should be promptly recorded. The system should ensure that correct amount has been recorded and correct account has been selected. It should also be seen that correct period has been use for recording the transactions. There is an accrual concept according to which transactions are recorded on the basis of accrual rather than receipts of the payments of cash.

3. SAFEGUARDING OF ASSETS: The system should ensure the safeguarding of the assets. One way is to restrict the use of assets to the bona fide use only. For example, no one except cashier should be allowed to handle the cash and all cash should be kept under lock and key.

4. COMPARISION OF ASSETS: The system should provide that at intervals recorded assets are compared with physically present assets and any differences are inquired into.

5. ADHERENCE TO MANAGEMENT POLICIES:

The system should ensure that all policies and procedures established by the management are followed during the course of business. For example, the management may have a policy of selling goods only for cash.

6. PREVENTION AND DETECTION OF FRAUDS AND ERRORS: One of the most important objectives of a system of controls is to eliminate the possibilities for fraud and to minimize the chances of errors. This view is particularly important in certain types of businesses like banks and insurance companies that deal with large sums of cash balances.

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The system should ensure that the frauds are prevented and errors are identified and rectified on a timely basis.

7. TIMELY PREPARATION OF FINANCIAL INFORMATION: Timely preparation of reliable financial information, significant balance sheets, and income statements are the important objects. The particular thing is that the information should be reliable and should be conveyed in time. IAS Presentation of Financial Statements states that timeliness and reliability are important characteristics of financial statements but there is a conflict between the two. To obtain reliable information we should wait and see the consequences but we will be late. If we prepare financial statements early, we need to use many estimates that will be confirmed later on. It suggests that the financial statements should be reliable in all material respects and should be provided to users on a timely basis.

8. OTHER MANAGEMENT OBJECTIVES: The management of a business has many objectives and the adequate system of internal control ensures that all the objectives of management are achieved.

9. COMPLIANCE WITH LAWS: Every organization has to follow some laws. All the companies are required to follow the Companies Ordinance. There may be certain laws that are operative only for certain types of businesses, for example, Environmental Protection Laws.

PRINCIPLES/ ESSENTIALS/ TYPES/ FEATURES OF INTERNAL CONTROL: The basic principles of financial internal control are explained below:

1. Financial and accounting operations must be separated, that is, the handling of cash and the recording of the movement should be done by different persons.

2. Responsibility for the performance of the job must be stated so that there may be no room for doubt.

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3. Too much confidence should not be pinned on one individual. Nearly all frauds are committed by the trusted officials or employees.

4. Rotation principle relating to transfer of an employee from one job to another should be the inflexible

guiding rule. This is an effective safeguard against fraud and is recognized as an important canon of sound organization.

5. Mechanization of work wherever feasible and practicable should be resorted to. Mechanical devices, such

as cash registers, recording time clocks, calculation machines, etc. should be introduced.

6. The work should be so arranged that work done by one employee should be promptly checked by another independent employee.

7. The arrangement of the work should be in such a manner that written record of the part played by each

employee should be maintained and the work should pass through several hands in a well-defined manner.

8. Clear and well-defined rules should be laid down and practically followed relating to dealing of cash, ordering, receiving and issuing goods etc. The instructions should be in writing in the form of accounting manuals.

9. Employees must be in bond so that the tempted employee can be stopped from committed fraud.

10. Double entry system of accounting must be followed.

AUDITOR�S INTEREST IN INTERNAL CONTROL: The auditor has interest in the review of the internal control procedures as it helps him in judging the:

a. Reliability in making audit program. b. Completing the audit assignments in time. c. Offering his comments and suggestions for improvement. d. Pointing out the leakages and shortcomings. e. Giving the report with confidence.

If the internal control is excellent, the other verification techniques need to be applied to a very limited extent. On the other hand, if there is very little internal control, the auditor is to apply audit techniques extensively in order to obtain evidences regarding the reliability of the data. It is true in auditing that the amount of work to be done and the extent and nature of the audit program varies directly with the existence and effectiveness of the internal control system. �The less internal control, the more audit tests, and verifications, the better the internal control, the less extensive will be the verification procedures.� Therefore, the primary interest of an auditor is to determine the extent of other tests and verification procedures that will include in his audit program.

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Inquiry must be made of the appropriate officers as to what internal control measures they establish within the operations of the business. Then after determining the controls extent, some tests must be made to check the functioning and effectiveness of the internal control system established and implemented. The auditor is not supposed to design any control procedures and installation of the same. He should only check the effectiveness of the system and the procedures being applied. INTERNAL AUDIT: The Institute of Internal Auditors has defined internal audit as: �Internal Auditing is an independent appraisal activity within an organization for the review of operations such as a service to management. It is a managerial control which functions by measuring and evaluating the effectiveness of other controls.� ROLE OF INTERNAL AUDIT: The role of internal audit is as follows:

1. Reliability and integrity of information. 2. Compliance with policies, plans, procedures, laws and regulations. 3. Safeguarding of assets. 4. Economical and efficient use of resources. 5. Accomplishment of established objectives and goals for operations or programs.

DIFFERENCE BETWEEN INTERNAL AUDIT, INTERNAL CHECK, INTERNAL CONTROL:

1. INTERNAL AUDIT: It is a continuous review of operations and records undertaken within the business and is normally done by specially assigned staff. It should operate independently of the internal check and in no case should divest anyone of the responsibilities placed upon him.

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2. INTERNAL CHECK: It means a system under which the work relating to carrying out and recording of transactions is allocated amongst various persons in such a manner that the work of one person is automatically checked by another and thus possibilities of fraud or error or irregularity are minimized or completely eliminated.

3. INTERNAL CONTROL: Internal control means not only internal check and internal audit, but the whole system of controls, financial and otherwise, established by the management in order to carry on the business of the company in an orderly manner, safeguard its assets and secure as far as possible the accuracy and reliability of its records.

DIFFERENCE BETWEEN INTERNAL AUDITING/ AUDITOR AND EXTERNAL AUDITING/ AUDITOR:

1. APPOINTMENT:

a. INTERNAL AUDITING/ AUDITOR: They are appointed by the management.

b. EXTERNAL AUDITING/ AUDITOR: They are appointed by the shareholders.

2. NATURE:

a. INTERNAL AUDITING/ AUDITOR: He is an employee of the company.

b. EXTERNAL AUDITING/ AUDITOR: He is an outsider.

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3. MAJOR CONCERN:

a. INTERNAL AUDITING/ AUDITOR: His major concern is to serve the needs of the management.

b. EXTERNAL AUDITING/ AUDITOR: His major concern is the compliance of statutory requirements.

4. BASIC JOB:

a. INTERNAL AUDITING/ AUDITOR: His basic job is to review the operations and internal controls for developing improvements and ensuring compliance of policies and procedures.

b. EXTERNAL AUDITING/ AUDITOR: His basic job is the expression of an independent opinion on financial statements.

5. SCOPE OF WORK:

a. INTERNAL AUDITING/ AUDITOR: The scope of work of an internal auditor is determined by the management.

b. EXTERNAL AUDITING/ AUDITOR: The scope of work of an external auditor is determined by the statutes.

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DIFFERENCE BETWEEN AUDITING AND INVESTIGATION:

NO. 1

• AUDITING: Audit is conducted on behalf of the shareholders.

• INVESTIGATION: Investigation is carried out on behalf of outsiders who intend to purchase the business or who wish to lend money and thus, want to know the financial position of the company.

NO. 2

• AUDITING: Accounts of a joint stock company must be audited according to law.

• INVESTIGATION: The accounts of a joint stock company may be investigated into.

NO. 3

• AUDITING: The audit of accounts is usually for a year or six months.

• INVESTIGATION: Investigation may cover a period extending over three to seven years.

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NO. 4

• AUDITING: The accounts are audited with a view to ascertain whether or not the balance sheet is drawn up according to law and that the profit and loss account and balance sheet show a true view of the state of affairs of a company.

• INVESTIGATION: Investigation is conducted with a particular object in view, i.e., to know the financial position of the company or its earning capacity.

NO. 5

• AUDITING: Audit includes an examination of the books of accounts of a business.

• INVESTIGATION: Investigation is not only an examination of accounts but it is also an enquiry into several other factors affecting the business, such as frauds, etc.

NO. 6

• AUDITING: Audited accounts are not audited again.

• INVESTIGATION: Investigation may be conducted even though the accounts have been audited.

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CHAPTER NO. 6

DEFINITION OF AUDIT TECHINQUES: Audit techniques may be defines as: �The methods used by auditors for collection of evidence on order to enable them to form and give a professional opinion are called the audit techniques.� Another definition of audit techniques may be as follows: �Audit techniques are tools, methods, or processes by means of which an auditor collects evidences to support his opinion in respect of the proportions or assertions submitted by the client to him for his examination.� TYPES OF AUDIT TECHNIQUES: Audit techniques applied for collection of the required evidences by the auditor to support his opinion will differ from situation. The auditor must, from time to time, review, amend and modify his audit techniques in the light of each audit objective, nature and circumstances because no audit technique is final and suitable for all circumstances. The audit techniques may be classified and defined as follows:

1. POSTING VERIFICATION: Tracing selected items, recorded in one source, to another source to establish the consistency of the recording process.

2. EXTENSION VERIFICATION: Multiplying two or more amounts to prove the reliability of the totals.

3. VOUCHING: A careful examination of all original evidences, such as invoices, statements, receipts, correspondence, minutes, contracts, etc., prove the correctness of the entities in the books of accounts and to prove that no transactions should be omitted from the books. De� Paula has defined vouching in these words:

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�Vouching does not mean merely the inspection of receipts with the cash book, but includes the examination of receipts with the transaction of a business together with documentary and other evidences of different validity to satisfy an auditor that such transactions are in order and have been authorized and are properly recorded in the books.�

4. CONFIRMATION: An independent communication by the auditor with the third party to confirm the correctness of the figures and validity of the client�s records. The auditor obtains statements in writing and certificates from debtors and creditors, etc. The auditor adopts direct mail method.

5. PHYSICAL EXAMINATION: This is carried out in respect of tangible assets as shown by the books of accounts of the client. Physical examination includes inspection, counting, identification, measurement and quality check. The auditor may observe the process of stocking done by the staff of the client. Assets that are not easily identifiable may create some problems in the way of physical examination.

6. RECONCILIATION: This is another audit techniques manually used by an auditor during the course of an audit. Where tow or more related items do not agree, it becomes essential to adopt the reconciliation techniques.

7. TESTING: This technique involves the selection of representative items from the records and examining them for reaching a conclusion about the trend of the whole activity. The items selected must be sufficiently representative of the whole data.

8. ANALYSIS OF THE FINANCIAL STATEMENTS: It is the audit technique that involves the working of various financial ratios between different periods. Sometimes such ratios are calculated between those of enterprise and other similar organizations. The object is to ensure whether these have a logical relationship. Such ratios may be profitability ratio, solvency ratio, activity ratio, etc.

9. SCANNING:

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This technique can be employed only by an experienced auditor. Such auditor may make a wide sweeping search to find out which of the entries are regular, consistent, and logical, and which are not. The irregular and inconsistent entries can be examined in more detail.

10. DOCUMENTORY EXAMINATION: This technique more or less is the same as vouching technique. Under this method, documentary evidence is examined to prove the reliability. The auditor should ensure that the transactions are properly recorded in the books of accounts.

11. FLOW CHARTING: This technique is used to describe graphically the issues of transactions through different stages from beginning to end.

12. ELECTRONIC DATA PROCESSING: This technique simplifies the conduct of audit because the numbers of errors are excluded to the minimum as the element is eliminated.

13. INSPECTION: The auditor, before beginning his examination and review of the financial statements, should arrange and do inspection of the client�s office, plant, branches, sales office, etc. to obtain understanding of the plant layout, manufacturing process, principle product, control and safeguard of inventories, the book and record maintained and the people employed. Inspection consists of examining records; documents or tangible assets that will provide reliable audit evidence to the auditor.

14. OBSERVATION: The auditor, before beginning the verification of specific transactions and accounts, must make a general observation of various policies and procedures or plans followed by the client in maintaining the official records. This will enable the auditor to know whether or not the transaction, appearing in the books, are properly authorized and executed in accordance with the policies established by the management.

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15. INQUIRY: The auditor, before starting the actual work of audit, should make an enquiry about the basic information, such as, laws of the partnership agreement, contracts, income tax, financial statements, and audit report of the past periods, internal control system, etc. Inquiring consists of seeking information about the persons inside and outside the entity. Inquiry is always connected with confirmation.

16. COMPUTATION. COSTING: Computation consists of checking the arithmetical calculations of the documents and accounting records.

17. MANAGEMENT PRESENTATION: The preparation of accounts is the responsibility of the management. Management representation letters remind the management of their responsibility for the completion of the accounts.

18. SAMPLING TECHNIQUES: It is also called test check. Audit sampling is the application of substantive procedures to less than 100% of the items within an account balance, to enable the auditor to obtain and evaluate evidence of some characteristics of the balance and to form a conclusion concerning that characteristic.

19. COMPLIANCE: These tests are designed to obtain reasonable assurance that the internal controls on which audit reliance is to be placed are in effect.

20. SUBSTANTIVE TESTS: Substantive tests are those tests of transactions and balances and other procedures such as an analytical review which provides audit evidence as to the completeness, accuracy, and validity of the information contained in the accounting records or in financial statements.

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CHAPTER NO. 7 AUDIT PROGRAMME: �An audit program is a detailed outline of the auditing work to be performed, specifying the procedures to be followed in verification of each item in the financial statements and giving them the estimated time required.� As each step in the audit program is completed, the date, the auditor�s initials and the actual time consumed may be entered opposite the item. Thus, an audit program serves as a useful tool both in scheduling and in controlling audit work. These written instructions enable inexperienced auditors to work effectively with less personal supervision than would otherwise be required, and permit seniors and managers to concentrate upon the features of the examination which demand a high degree of concentration. PURPOSES OF AUDIT PROGRAMMES: The purpose of an audit program may be detailed as follows:

1. COORDINATION OF AUDIT PROCEDURES: The auditor must have some way of organizing the many steps to be performed in an audit. Therefore, a well-conceived audit program is a real help in achieving coordination and avoiding duplication in such circumstances.

2. EVIDENCE OF THE EXTENT OF VERIFICATION: When the auditors have completed their work. They have only working papers that they have prepared during the course of their verification as evidence to their work and one of the most important work papers is the audit program itself.

3. PROOF: The audit program is also used as a proof that the work was actually done if such proof ever becomes necessary.

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4. GUIDE TO THE AUDITOR: An audit program, being a detailed plan of the auditing work to be performed, specifying the procedures to be followed in verification of each item in the financial statement and giving the estimated time required, serves as a guide to the auditor during the course of the audit.

5. ASCERTAINING THE PROGRESS: As each step in the audit program is completed, the date, the audit clerk�s initials, and the actual time consumed may be entered opposite the item. Thus, the audit program serves as a useful tool in scheduling and in controlling audit work.

6. SERVES AS A CHECK-OFF LIST: Audit program serves as a check-off list towards the close of the audit to be certain that no item or procedure has been missed.

ADVANTAGES/ IMPORTANCE OF AUDIT PROGRAMME:

1. It ensures that all necessary work has been done and nothing has been omitted. 2. The auditor is in a position to know about the progress of the work done by his assistants.

3. A uniformity of the work can be attained, as the same program will be followed at subsequent audits.

4. Work of the audit can be divided amongst the different juniors who will be responsible for their work.

5. It simplifies the allocation of work to various grades of audit clerks.

6. In case of a charge of negligence against the auditor for not having done some work, the auditor can

defend himself that the work had been done by him or his assistant who had duly signed the audit program.

7. In case any fraud or error has remained undetected the responsibility for negligence can be fixed on the clerk who had performed that work as his initials are put on the audit program.

8. It facilitates the final review before the report is signed.

9. The audit program is guide to duties for a new clerk.

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TYPES OF AUDIT PROGRAMMES:

1. ALL-PURPOSE, STANDARD AUDIT PROGRAMME: Some auditors make use of pre-printed audit programs, covering special sections of the work such as that on cash, inventory, etc., and the detailed or general work for every audit assignment.

• ADVANTAGES:

1. TIME-SAVING: Pre-established programs are time saving since the auditor need not draft by himself a separate audit program for such audit.

2. LABOR SAVING: Such programs are also labor saving as the necessity of a staff in its drafting is eliminated.

3. DETAILED OPERATIONS: The detailed audit instructions in the standard program gives assurance that essential steps in verification will not be overlooked.

• DISADVANTAGES:

1. MECHANICAL:

Standard audit program proves to be very mechanical. The initiative and creativity of the clerk in charge to a large extent stifled and the audit is opt to become too automatic in its nature.

2. NOT APPLICABLE TO PECULIAR SITUATIONS: Such pre-established programs are not applicable to specific situations and require modification.

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2. MODIFIED/ STANDARD FORM OF AUDIT PROGRAMME: This type is a modification of the first type. Those auditors who agree that there is no uniform set of procedures equally applicable to all companies under all conditions keep room for adjustments in the pre-printed program according to the specific requirement of the client�s state of business.

3. TAILOR-MADE AUDIT PROGRAMME: Many auditors draft their own program for each situation as they meet it, relying on their own knowledge of auditing techniques and their past experience and keeping in view the exact requirements of the business based on the auditor�s judgment of the existing accounting and internal control system.

• ADVANTAGES: Tailor-made programs enjoy the advantage of being tailored to the exact requirements of the specific audit engagement.

• DISADVANTAGES: The selection of audit procedures appropriate to the circumstances requires professional judgment based on extensive auditing experience. This poses the possibility that any essential procedure may be missed by the auditor.

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CHAPTER NO. 8 AUDIT EVIDENCE:

�Audit Evidence� is all the information used by the auditor in arriving at the conclusion on which the audit opinion is based. It also includes the information contained in the accounting records underlying the financial statements and other information. Audit evidence, which is cumulative in nature, includes audit evidence obtained from audit procedures performed during the course of the audit and may include audit evidence obtained from other sources such as previous audits. The auditor obtains some audit evidence by testing the accounting records, minutes of meetings, confirmation from third parties. Information obtained by the auditor from such audit procedures as inquiry, observation, and inspection.

APPLICABILITY OF VARIOUS TECHNIQUES FOR VARIOUS AUDIT EVIDENCES:

1. INSPECTING: Inspection consists of examining records or documents in paper form, electronic form, or other media. Inspection of records and documents provides audit evidence of varying degrees of reliability, depending on their nature and source.

2. PHYSICAL EXAMINATION: Inspection of tangible assets consists of physical examination of the assets. Inspection of tangible assets may provide reliable audit evidence with respect to their existence, but not necessarily about the entity�s rights and obligations or the valuation of the assets.

3. OBSERVATION: Observation consists of looking at a process or procedure being performed by others, example, observation of the counting of inventories.

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4. INQUIRY:

Inquiry consists of seeking information about persons throughout the entity or outside the entity. Inquiry is an audit procedure that is used extensively throughout the audit. Inquiries may range from formal written inquiries to informal oral inquiries.

5. CONFIRMATION: Confirmation is the process of obtaining a representation of information directly from a third party. Confirmations are frequently used in account balances. Confirmations are also used to obtain audit evidence about the absence of certain conditions.

6. RECALCULATION: Recalculation consists of checking the mathematical accuracy of documents or records, which may be performed through the use of information technology.

7. REPERFORMANCE: Reperformance is the auditor�s independent execution of procedures of controls that were originally performed as part of the entity�s internal control, either manually or through the use of CAAT (Computerized Assisted Audit Techniques).

8. ANALYTICAL PROCEDURES: Analytical procedures consist of evaluations of financial information made by a study of relationships among both financial and non-financial data. Analytical fluctuations and relationships that deviate from predicted amounts.

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CHAPTER NO. 9 DIVISIBLE PROFITS: PROFITS:

Profits may be defined as follows:

1. The profit of the business during a given period is the excess over the expenditure for the period. 2. It is the excess of assets over the liabilities and the capital between the two periods.

DIVISIBLE PROFITS: The term �divisible profits� means all profits that can be legally distributed to the shareholders of the company. The Ordinance reads as under: �No dividends shall be paid by company otherwise tehn out of profits of the company�.

GUIDING PRINCIPLES OF DIVISIBLE PROFITS:

1. In no circumstances a dividend can be paid out of the capital. 2. In every case the requirements of the memorandum and articles of association of the company must be

faithfully compiled with.

3. According to the provisions of the Ordinance, �The company in general meeting may declare dividend, no dividend shall exceed the amount recommended by the directors.�

4. Provisions of the ordinance provides:

a. If any expenditure allocatable to revenue is charged to capital with a view to swelling the profit of

the company improperly, b. If a company paid a dividend in spite of the fact that the profit and loss account indicates the loss

and there are no other undistributed profits, c. If a company distributes the sale-proceeds of one of its fixed assets.

5. It is very desirable that the dividend paid year after year should as far as possible be uniform.

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6. The future financial needs of the company should not be over-looked.

7. The rate of dividend in a really stable and well-managed company is not increased unless the directors

have satisfied themselves that a later decrease will not become necessary.

8. In a new company, there need not be any hurry to start paying dividend and the rate of the dividend should be fairly low in order to provide against any future contingency.

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CHAPTER NO. 10 ERRORS: The international Auditing Guidelines No. 3 defines error as, �The term error refers to unintentional mistakes in financial information, such as,

a. Mathematical or clerical mistakes in the underlying records and accounting data, b. Oversight or misinterpretation of facts, or, c. Misapplication of accounting policies.�

TYPES OF ERRORS:

1. CLERICAL ERRORS: Clerical errors are of two types:

a. ERRORS OF OMISSION: An error of omission is when a transaction has not been recorded in the books of account either wholly or partially. In the former case, it will not be detected by the trial balance. In case the transaction has been partially recorded, it will affect the trail balance and ultimately the profit and loss account.

b. ERRORS OF COMMISSION: When a transaction has been recorded but has been wrongly entered in the books or original entry or in the ledger, example, incorrect entries in the original records, calculations, etc. Such entries may be detected by the non-agreement of the trail balance.

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2. ERRORS OF PRINCIPLE: Such entries arise when the entries are not recorded according to the fundamental principles of accountancy. Such an error not disclosed by the trial balance or by routine checking. It can be detected only by searching, enquiry and checking.

3. COMPENSATING ERRORS: A compensating error is one that is counterbalanced by any affect the trial balance and the profit and loss account.

4. ERRORS OF DUPLICATION: Such errors arise when an entry in a book of original entry has been made twice and has also been posted twice.

FRAUD: International Accounting Guideline No. 2 defines fraud as, �The term fraud refers to international misrepresentation of financial information by one or more individuals among management, employees or third parties.� TYPES OF FRAUDS:

1. EMBEZZLEMENT OF CASH: Cash may be misappropriated by:

a. Omitting to enter any cash that has been actually received, b. Entering less amount than what has been actually received, c. Making fictitious entries on the payment side of the cashbook.

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2. MISAPPROPRIATION OF GOODS: Fraud may also be in respect of goods. This type of fraud is very difficult to detect. Proper methods of keeping accounts of purchases and sales, periodical checking of stocks, comparing profit of sales of two periods may help to avoid misappropriation of goods.

3. FRADULENT MANIPULATION OF ACCOUNTS: This type of fraud is more difficult to discover as it is usually committed by directors or managers or other responsible officials. For example,

a. Not providing any depreciation or providing less depreciation or providing more depreciation, b. Under-valuation or over-valuation of assets and liabilities, c. Showing fictitious sales or purchases or returns in order to show more profits or less profit.

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CHAPTER NO. 11 UNQUALIFIED/ CLEAN AUDIT REPORT:

ABC Industries (Private) Limited AUDITOR�S REPORT TO THE MEMBERS

We have audited the annexed balance sheet of ABC Industries (Private) Limited as at June 30, 2006 and the related profit and loss account, together with the notes thereon, for the year then ended and we state that we have obtained all the information and explanations which, to the best of our knowledge and belief were necessary for the purpose of our audit and after due verification thereof, we report that:

A. In our opinion, proper books of account have been kept by the company as required by Section 230 of the Companies Ordinance, 1984.

B. In our opinion,

1. The balance sheet and profit and loss account together with the notes thereon have been drawn

upon in conformity with the Companies Ordinance, 1984, and are in agreement with the books of account and are further in accordance with accounting policies consistently applied,

2. The expenditure incurred during the year was for the purpose of the company�s business, and,

3. The business conducted, investments made and the expenditure incurred during the year were in

accordance with the objects of the company,

C. In our opinion and to the best of our information and according to the explanations given to us, the balance

sheet, profit and loss account together with the notes forming part thereof, give the information required by the Companies Ordinance, 1984, in the manner so required and respectively give a true and fair view of state of the company�s affairs as at June 30, 2006, and of the profit for the year then ended; and,

D. In our opinion, no Zakat was deductible at source under the Zakat And Ushr Ordinance, 1980.

XYZ & Company Chartered Accountants

Karachi: June 30, 2006

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QUALIFIED AUDIT REPORT:

ABC Industries (Private) Limited AUDITOR�S REPORT TO THE MEMBERS

We have audited the annexed balance sheet of ABC Industries (Pvt.) Ltd., as at December 31, 2006 and the related profit and loss account and statement of changes in financial position for the year then ended together with the notes thereto. We have obtained all the information and explanation, which to the best of our knowledge and belief were necessary for the purpose of the audit, and we state that:

a. Provision for depreciation on plant assets is inadequate to the extent of Rs. XXX, b. Allowance for bad and doubtful debts on accounts receivable is inadequate to the extent of Rs. XXX,

c. A sum of Rs. XXX has been advanced to a director of the company in contravention of the Companies

Ordinance, 1984,

d. The trading profit of the company is increased by Rs. XX due to a change in the basis of inventory valuation.

Subject to the above, in our opinion,

a. Proper books of accounts as required by Sec. 230 of the Companies Ordinance, 1984, have been kept by the company,

b. The balance sheet, profit and loss account have been drawn up in conformity with the Companies

Ordinance, 1984, and are in agreement with the books of account,

c. The expenditure incurred during the year was for the purpose of company�s business,

d. Business conducted, investments made and expenditures incurred during the year were in accordance with the objects of the company; and,

e. No Zakat was deductible at source under the Zakat & Ushr Ordinance, 1980.

XYZ & Company Chartered Accountants

Karachi: December 31, 2006

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CHAPTER NO. 12

INCOME TAX LAW CENTRAL BOARD OF REVENUE (C.B.R.): The Central Board of Revenue (C.B.R.) is the highest executive authority of income tax in Pakistan. It is a statutory body appointed by the Central Govt. for the purpose of tax collection in the country, by the authority of Central Board of Revenue Act, 1924. Apart from income tax, collection of sales tax and wealth tax is also the responsibility of C.B.R. The Board consists of 4 members who are joint secretaries to the Govt. of Pakistan. POWERS AND FUNCTIONS OF CENTRAL BOARD OF REVENUE (C.B.R):

1. To declare a foreign association, whether incorporated or not, to be a company for the purpose of income tax.

2. To declare a period to be treated as income year in case of any person or any source of income.

3. To appoint as many Regional Commissioners of Income Tax, Directors of Survey, Inspectors,

Commissioners of Income Tax and Income Tax Officers and other executives and staff as may be necessary

4. To assign work to Regional Commissioners, Directors of Survey, Inspectors and Commissioners.

5. If two Regional Commissioners of Income Tax are not in agreement regarding the jurisdiction of an Income

Tax Officer to assess any person, the Board has the power to determine the disputed jurisdiction.

6. The Board can authorize any person to assist, guide or instruct the I.T.O. in the course of any proceedings

7. The Board can appoint sufficient number of qualified persons as may be required.

8. It registers qualified persons as income tax practitioners.

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BASIS OF PRESENT INCOME TAX LAWS AND PRACTICE IN PAKISTAN: INTRODUCTION: Since ancient times, governments have been collecting revenues from their population in different forms. It was necessary in order to meet the different expenditures which the govt. had to incur. The nature and extent of the expenditures incurred by the governments have undergone a lot of changes in the modern world. To meet all these expenditures, a government has to generate internal revenue from different sources. In our country, like all other countries of the world, the government receives different types of taxes in order to finance its day-to-day expenses, and defense and development projects. These taxes includes:

a. Custom and excise duty, b. Income tax, c. Sales tax, d. Wealth Tax, etc.

The government also introduced �Zakat� & �Ushr� system, the income from which is spent only according to the Quranic injunctions. OBJECTS OF INCOME TAX ORDINANCE:

1. To simplify the law. 2. To arrange the provisions of Income Tax Law. 3. To eliminate tax evasion. 4. To evolve an equitable tax system. 5. To rationalize and amplify the existing provisions and introduce new ones whenever necessary.

BASIS OF INCOME TAX LAW AND PRACTICE IN PAKISTAN: The income-tax law and practice in Pakistan is based on the following documents, traditions and legal rulings:

a. Income-Tax Ordinance, 2001. b. Income-Tax Rules framed by the C.B.R. c. Notifications, instructions and orders issued by C.B.R. in connection with the law and practice of income

tax. d. Annual Finance Act issued by the Ministry of Finance to give effect to budget. e. Income-Tax case law. f. Income-Tax Manual. g. Legal Opinions. h. Rulings and judgments on income-tax matters by courts.

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CHAPTER NO. 13 IMPORTANT TERMS: ASSESSMENT: Assessment means testing and verification of information filled by the taxpayer. A complete return of income furnished by a taxpayer is tested as to be an assessment order issued by the Commissioner on the day the return was furnished. This is called normal assessment. ASSESSMENT YEAR: Assessment year means a period of 12 months beginning on the first day of July. The year in which income is taxed is called assessment year. INCOME YEAR: Income is earned in a certain financial year and is taxed in the next financial year. Earning year is known as the income year. TAX: Tax means any tax imposed under Chapter II of Income Tax Ordinance, 2001 and includes:

a. Any penalty fee or other charge, or b. Any sum or amount payable under this ordinance.

TAX PAYER: Taxpayer means any person who derives an amount chargeable to tax under the Income Tax Ordinance, 2001, and includes:

a. Any person who is required to deduct or collect tax withholding tax, or b. Any person required to furnish a return of income or pay tax under this ordinance.

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TAX YEAR: Tax year means a period of 12 months ending on 30th June. It is called a normal tax year. PERSON: The term person for the purpose of Income Tax Ordinance, 2001 shall be treated as person:

a. Individual b. Company c. Association of Persons d. Federal Government e. Foreign Government f. Firm g. Local Authority h. Trust i. Provisional Government

TOTAL INCOME: Total Income means:

a. Total amount of income referred in Sec. 10 and computed in the manner laid down in the ordinance. b. Any income which is to be included in the total income of tax-payer under the law.

RESIDENT: A person is resident person for a tax year if the person is:

a. A resident individual, resident company for the year, b. The Federal Government.

A RESIDENT PAYS TAX ON:

a. Income received in Pakistan, by an assessee or on his behalf. b. Income deemed to be received in Pakistan.

c. Income accrues or arises in Pakistan during the income year.

d. Income deemed to accrue or arise in Pakistan during the income year.

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e. Income accruing outside Pakistan during the income year. A NON-RESIDENT PAYS TAX ON:

a. Income received in Pakistan during the income year. b. Income deemed to be received in Pakistan.

c. Income accrued in Pakistan.

d. Income deemed to accrue in Pakistan.

INCOME TAX AUTHORITIES: Under the Income Tax Ordinance two types of authorities have been prescribed, namely, judicial and administrative. There are following income tax authorities:

a. Central Board of Revenue. b. Regional Commissioner of Income Tax. c. Commissioner of Income Tax. d. Commissioner of Income Tax (Appeals). e. Taxation Officers.

COMMISSIONER OF INCOME TAX: Commissioner of Income Tax means a person appointed to be a commissioner of income tax and includes a taxation officer vested with all or any of the persons and functions of commissioner. They are appointed by C.B.R. POWERS:

1. Rectify mistakes. 2. Transfer jurisdiction. 3. Launch prosecution.

TAXATION OFFICER (I.T.O): Taxation officer means additional commissioner, D.C, assistant commissioner, I.T.O., special officer or any other officer under the ordinance. He is appointed by C.B.R.

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POWERS:

1. Approves imposition of penalty. 2. Make inquiries. 3. Rectify Mistakes. 4. Exercise powers of D.C. 5. Enter any place and make inventory of articles.

TAX RECOVERY OFFICER: He has the status of D.C. and his powers, duties and functions are similar to that of a D.C. He is appointed by the C.B.R. POWERS:

1. Proceeds to recover tax due. 2. Attach and sell property. 3. Appoint receiver. 4. Arrest and detain assessee up to 6 months.

APPELLATE TRIBUNAL: The Appellate Tribunal is appointed by the Federal Government. It is a second court of appeal. The income tax department, if not satisfied with the decision of commissioner of income tax can appeal to Appellate Tribunal. The Appellate Tribunal consists of two types of members:

a. Judicial Member, and b. Accountant Member.

One member is appointed as the Chairman. The decision of the Appellate Tribunal is final. SALES TAX: Subject to the provision of Sales Tax Act. There shall be charged, levied and paid a tax known as Sales Tax, at the rate of 15% of the value of:

a. Taxable supplies made by a registered person in the course of any taxable activity carried on by him, and, b. Goods imported.

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ASSESSOR: An assessor is an appointed official, charged with the responsibility to determine the value of taxable property of a place. This information is then used by the locality to determine the necessary rate of taxation to support the community�s annual budget. TAXABLE INCOME: Taxable income is the portion of income that is the subject of taxation according to the laws that determine what is income and the taxation rate of that income. Taxable income refers to an individual�s liability on his earnings adjusted for what is regarded as taxable by the government statute.