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Fundamentals of Auditing

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Fundamentals of Auditing ­ACC 311
VU
Lesson 23
SUFFICIENT APPROPRIATE AUDIT EVIDENCE
AND
TESTING THE SALES SYSTEM
Recap:
Audit evidence includes: the information contained in the accounting records underlying the financial
statements.
Audit evidence might include:
 Documents (invoices, credit notes, cash receipts)
 Accounting entries (write down to NRV, depreciation)
 Answers from the management (Provisions)
 Information from third parties (banks, debtors)
 Computations (depreciation, accruals, provisions)
 Observations (inventory count)
Sufficiency:
The measure of quantity of audit evidence.
The measure of quality i.e. relevance and reliability of audit evidence.
Appropriateness:
Key questions for the auditor to consider therefore will be:
1. Do I have enough evidence to reach a conclusion on this audit area?
2. Is the evidence that I have, reliable enough to, allow me to reach a conclusion on this area of the
audit?
Assertions in obtaining Audit Evidence
(a)
Assertions about classes of transactions and events for the period under audit;
i.
Occurrence ­ transactions and events that have been recorded have occurred and pertain
to the entity;
ii.
Completeness ­ all transactions and events that should have been recorded have been
recorded (accruals & depreciation);
iii.
Accuracy ­ amounts and other data relating to recorded transactions and events have been
recorded appropriately. (valuation and estimations)
iv.
Cutoff ­ transactions and events have been recorded in the proper period.
v.
Classification ­ transactions and events have been recorded in the proper accounts.
Assertions about account balances at the period end.
(b)
i.
Existence ­ assets, liabilities, and equity interests exist;
ii.
Rights and obligations ­ the entity holds or controls the rights to assets, and liabilities are
the obligations of the entity;
iii.
Completeness ­ all assets, liabilities and equity interests that should have been recorded
have been recorded;
iv.
Valuation and allocation ­ assets, liabilities, and equity interests are included in the financial
statements at appropriate amounts and any resulting valuation or allocation adjustments
are appropriately recorded.
Assertions about presentation and disclosure:
(c)
i.
Occurrence and rights and obligations ­ disclosed events, transactions and other matters
have occurred and pertain to the entity;
ii.
Completeness ­ all disclosures that should have been included in the financial statements
have been included;
iii.
Classification and understandability ­ financial information is appropriately presented and
described, and disclosures are clearly expressed;
iv.
Accuracy and valuation ­ financial and other information are disclosed fairly and at
appropriate amounts.
Audit procedures for obtaining Audit Evidence
The auditor uses one or more types of audit procedures described below:
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Fundamentals of Auditing ­ACC 311
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(i)
Inspection of Records or Documents
It consists of examining records or documents whether internal or external, in paper form,
electronic form, or other media. Inspection provides evidence of varying degrees of reliability
depending on their nature and source and in the case of internal records, on effectiveness of
controls over their production.
(ii)
Inspection of Tangible Assets
It consists of physical examination of the assets. It may provide reliable audit evidence of their
existence cannot necessarily about other assertions.
(iii)
Inquiry
It means seeking information of knowledgeable persons throughout the entity or outside the entity.
Those may be formal written or informal oral. It provides an auditor with new information or
corroborative evidences. It may also bring to high information different from the one possessed by
the auditor. Certain oral inquiries might be got confirmed through written representations.
(iv)
Confirmations
It is a specific type of inquiry. It is the process of obtaining a representation of information or an
existing condition directly from a third party. Confirmations are sought from debtors, creditors,
bankers, legal advisors etc.
(v)
Recalculation
It consists of checking the mathematical accuracy of documents or records. It can be performed
through use of information technology.
(vi)
Re-performance
It is the auditor's independent execution of procedures or controls that were originally performed
as part of the entity's internal control, either manually or through the use of CAATs, for example,
reperforming the aging of accounts receivable.
(vii)
Analytical procedures
It consists of evaluations of financial information made by a study of plausible relationship among
both financial and non-financial data. It includes investigation of significant fluctuations found and
the relationship that are inconsistent.
TESTING THE SALES SYSTEM
Control Objectives
For many businesses, sales are made on credit and so objectives for the sales cycle includes control debtors
as well.
These control objectives include:
a) Customers' orders should be authorized, controlled and recorded in order to execute them
promptly
b) Goods shipped and work completed should be controlled to ensure that invoices are issued and
revenue recorded for all sales.
c) Goods returned and claims by customers (for example, in respect of damaged goods) should be
controlled in order to determine the liability for goods returned and claims received. .
d) Invoices and credits should be appropriately checked for accuracy and should be authorized before
being entered in the receivables' records.
e) Authorized customer transactions, and only those transactions, should be accurately entered in the
accounting records.
f) There should be procedures to ensure that sales invoices are subsequently paid by customers and
that doubtful amounts are identified in order to determine any provisions or write offs required
Control procedures over sales and debtors
There are a large number of controls that may be required in the sales cycle due to the importance of this
area in any business and the possible opportunities that exist for diverting sales and cash receipts away from
the business.
Typical control procedures at key stages of the sales cycle are:
1. Orders
2. Dispatch
3. Invoicing and credit notes
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Fundamentals of Auditing ­ACC 311
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4. Returns inwards
5. Receivables
6. Bad Debts
(a)
Orders
(i)
Existing customers should be allocated a credit limit and it should be ascertained whether this limit
is to be exceeded if the new order is accepted. If so the matter should be referred to credit control.
(ii)
Any new customer should be referred to the credit control department before the order is accepted.
(iii)
All orders received should be recorded on pre-numbered sales order documents so that a check can
be made that all orders have been dealt with -a completeness check.
(iv)
All orders should be authorized before any goods are dispatched.
(v)
The sales order document should be used to produce a dispatch note for the goods outwards
department. No goods may be dispatched without a dispatch note.
(b) Dispatch
(i)
Dispatch notes should be pre-numbered and a register kept of them to enable them to be matched
with relate to sales invoices and customer orders.
(ii)
Dispatch notes should be authorized before goods leave the company.
(iii)
Regular checks should be made to ensure that all dispatches have been invoiced.
(c) Invoicing and Credit Notes
(i)
Sales invoices should be authorized by a responsible official and matched with the authorized order
and dispatch note.
(ii)
All invoices and credit notes should be entered In daybook records, the sales ledger, and sales
ledger control account. Batch totals should be maintained for this purpose.
(iii)
Sales invoices and credit notes should be checked for prices. casts and calculations by a person
other than the one preparing the invoice.
(iv)
All invoices and credit notes should be serially pre-numbered and regular sequence checks should
be carried out.
(v)
Credit notes should be authorized by someone unconnected with dispatch or sales ledger functions.
(vi)
Copies of cancelled invoices should be retained.
(vii)
Any cancellation of an invoice should lead to a cancellation of the related dispatch note.
(viii)
Cancelled (and free of charge) invoices should be signed by a responsible official.
(ix)
Each invoice should distinguish between different types of sales and, if relevant, different rates of
VAT or sales tax. Any coding of invoices should be periodically checked independently
(d) Returns
(i)
Any goods returned by the customer should be checked for obvious damage and, when accepted. a
document should be raised.
(ii)
All goods returned should be used to prepare appropriate credit notes
(e) Receivables/Debtors
(i)
A receivables ledger control account should be prepared regularly and checked to individual sales
ledger balances by an Independent official.
(ii)
Receivables ledger personnel should be independent of dispatch and cash receipt functions.
(iii)
Statements should be sent regularly to customers.
(iv)
Formal procedures should exist for following up overdue debts which should be highlighted either
by the preparation of an aged list of balances or by the preparation of regular customer statements.
(v)
Letters should be sent to customers for collection of overdue debts. A policy should be in place for
the Institution of legal proceeds where appropriate.
f) Bad debts
(i)
The authority to write off a bad debt should be in writing. Appropriate adjustments should be
made to the sales ledger and the control account
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Fundamentals of Auditing ­ACC 311
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(ii)
The use of court action or the writing-off of a bad debt should be authorised by an official
independent of the cash receipt function.
Tests of Control
Tests of control should be designed to check that the control procedures are being applied and that
objectives are being achieved. Tests may be appropriate under the following broad headings.
(a) Carry out sequence test checks on invoices, credit notes, dispatch notes and orders. Ensure that all
items are included and that there are no omissions or duplications.
(b) Check the existence of evidence for authorization in respect of:
i.
acceptance of the order (the creditworthiness check)
ii.
dispatch of goods
iii.
raising of the invoice or credit note
iv.
pricing and discounts
v.
write-off of bad debts.
Check both that the relevant signature exists and that the control has been applied.
(c) Seek evidence of checking of the arithmetical accuracy of:
i.
invoices, including pricing, and VAT and sales tax calculations
ii.
credit notes,
This is often done by means of a 'grid stamp' containing several signatures on the face of the document.
Ensure that the control has been applied by checking the accuracy of such invoices and credit notes.
(d) Check dispatch notes and goods returned notes to ensure that they are matched with invoices and
credit notes.
(e) Check that control account reconciliations have been performed and reviewed.
In all cases, tests should be performed on a sample basis.
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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