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Fundamentals of Auditing

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Fundamentals of Auditing ­ACC 311
VU
Lesson 41
AUDIT PLANNING
Audit Engagement letter
Evaluating Internal Audit Work/Review/Controlling
Where the external auditor has decided to place reliance on the work of internal auditor, he should
review the working papers to satisfy himself as to:-
i)
Audit programs are adequate.
ii)
The work is performed by trained staff and the work of assistants is properly supervised,
reviewed and documented.
iii)
Sufficient appropriate audit evidence was obtained.
iv)
Conclusions made are appropriate.
v)
Reports prepared are based on the work done.
vi)
Exceptions or unusual items have been properly resolved. The external auditor should
record all the working he has received. The external auditor should also test the work of
internal auditor.
Testing the Work of Internal Auditing
It can be done in the following ways:
i)
Re-performing the work done by internal auditor, on test basis, to ensure that the same
results are achieved;
ii)
Selecting a few similar items and perform independent test; and
iii)
Observation of internal auditing procedures.
Terms of Audit Engagements
Meaning and Objective
Audit Engagement Letter is written by the auditor to his client. The letter documents terms of
engagement as agreed between the auditor and the client.
Following are the components of Audit Engagement Letter
Principal Contents
i)
The objective of financial statements.
ii)
Management's responsibility for financial statements.
iii)
The scope of the audit.
iv)
The form of any reports or other communications.
v)
The fact that due to certain unavoidable factors, the auditors may not be able to detect all
material misstatements due to fraud or error.
vi)
Requirement of unrestricted access to records etc.
Optional Contents
i)
Arrangements regarding the planning of the audit.
ii)
Expectation of receiving written representations.
iii)
Request for confirmation of terms of engagement.
iv)
Description of any other letters or reports the auditor expects to issue to the client.
v)
Basis for computation of fees.
Contents to be included under Special Circumstances
i)
Arrangements concerning the involvement of other auditors, experts, internal auditors and
other client staff.
ii)
Arrangements to be made with predecessor auditor, in case of initial audit only.
iii)
Restriction on auditor's liability, if any.
Reference to any further agreements between the auditor and the client.
iv)
Note:  A specimen engagement letter as given in the AS is given at Annexure-2.
Audit of Components
In case of components (branch, subsidiary or division) the auditor has to decide whether to send a
separate engagement letter for the component. It would depend on the following:
i)
Who appoints auditor of the component.
ii)
Whether a separate audit report is to be issued on the component.
iii)
Legal requirements.
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Fundamentals of Auditing ­ACC 311
VU
iv)
The extent of any work performed by other auditors.
v)
Degree of ownership by parent.
vi)
Degree of independence of the component's management.
Recurring Audits
Should auditor write an engagement letter every year? Answer to this question is dependent on the
following factors:
i)
If client misunderstands the objective and scope of the audit.
ii)
Any revised or special terms of engagement.
iii)
A recent change of senior management, board of directors or ownership.
iv)
A significant change in nature or size of the client's business.
v)
Legal requirements.
Example of an Audit Engagement Letter
The following letter is for use as a guide in conjunction with the considerations outlined in this ISA
and will need to be varied according to individual requirements and circumstances.
To the Board of Directors or the appropriate representative of senior management:
You have requested that we audit the balance sheet of ..............as of ............., and the related
statements of income and cash flows for the year then ending. We are pleased to confirm our
acceptance and our understanding of this engagement by means of this letter. Our audit will be made
with the objective of our expressing an opinion on the financial statements.
We will conduct our audit in accordance with International Standards on Auditing (or relevant
national standards or practices). Those ISAs require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatements. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation.
Because of the test nature and other inherent limitations of an audit, together with the inherent
limitations of any accounting and internal control system, there is an unavoidable risk that even some
material misstatements may remain undiscovered.
In addition to our report on the financial statements, we expect to provide you with a separate letter
concerning any material weaknesses in accounting and internal control systems, which come to our
notice.
We remind you that the responsibility for the preparation of financial statements including adequate
disclosure is that of the management of the company. This includes the maintenance of adequate
accounting records and internal controls, the selection and application of accounting policies, and the
safeguarding of the assets of the company. As part of our audit process, we will request from
management written confirmation concerning representations made to us in connection with the
audit.
We look forward to full cooperation with your staff and we trust that they will make available to us
whatever records, documentation and other information are requested in connection with our audit.
Our fees, which will be billed as work progress, are based on the time required by the individuals
assigned to the engagement plus out-of-pocket expenses. Individual hourly rates vary according to the
degree of responsibility involved and the experience and skill required.
This letter will be effective for future years unless it is terminated, amended or superseded.
Please sign and return the attached copy of this letter to indicate that it is in accordance with your
understanding of the arrangements for our audit of the financial statements.
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Fundamentals of Auditing ­ACC 311
VU
XYZ & Co.
Acknowledged on behalf of
ABC Company by
(Signed)
Name and Title
Date ________
133
Table of Contents:
  1. AN INTRODUCTION
  2. AUDITORSí REPORT
  3. Advantages and Disadvantages of Auditing
  4. OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL STATEMENTS
  5. What is Reasonable Assurance
  6. LEGAL CONSIDERATION REGARDING AUDITING
  7. Appointment, Duties, Rights and Liabilities of Auditor
  8. LIABILITIES OF AN AUDITOR
  9. BOOKS OF ACCOUNT & FINANCIAL STATEMENTS
  10. Contents of Balance Sheet
  11. ENTITY AND ITS ENVIRONMENT AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT
  12. Business Operations
  13. Risk Assessment Procedures & Sources of Information
  14. Measurement and Review of the Entityís Financial Performance
  15. Definition & Components of Internal Control
  16. Auditing ASSIGNMENT
  17. Benefits of Internal Control to the entity
  18. Flow Charts and Internal Control Questionnaires
  19. Construction of an ICQ
  20. Audit evidence through Audit Procedures
  21. SUBSTANTIVE PROCEDURES
  22. Concept of Audit Evidence
  23. SUFFICIENT APPROPRIATE AUDIT EVIDENCE AND TESTING THE SALES SYSTEM
  24. Control Procedures over Sales and Debtors
  25. Control Procedures over Purchases and Payables
  26. TESTING THE PURCHASES SYSTEM
  27. TESTING THE PAYROLL SYSTEM
  28. TESTING THE CASH SYSTEM
  29. Controls over Banking of Receipts
  30. Control Procedures over Inventory
  31. TESTING THE NON-CURRENT ASSETS
  32. VERIFICATION APPROACH OF AUDIT
  33. VERIFICATION OF ASSETS
  34. LETTER OF REPRESENTATION VERIFICATION OF LIABILITIES
  35. VERIFICATION OF EQUITY
  36. VERIFICATION OF BANK BALANCES
  37. VERIFICATION OF STOCK-IN-TRADE AND STORE & SPARES
  38. AUDIT SAMPLING
  39. STATISTICAL SAMPLING
  40. CONSIDERING THE WORK OF INTERNAL AUDITING
  41. AUDIT PLANNING
  42. PLANNING AN AUDIT OF FINANCIAL STATEMENTS
  43. Audits of Small Entities
  44. AUDITORíS REPORT ON A COMPLETE SET OF GENERAL PURPOSE FINANCIALSTATEMENTS
  45. MODIFIED AUDITORíS REPORT