Audit programs and procedures

Audit procedures are procedures performed by an auditor in obtaining sufficient and appropriate evidence. These steps enable the auditor to form an opinion on the financial statements, whether they portray a true and fair view of the organisation's affairs. Auditors employ procedures to gather sufficient and appropriate evidence that will allow them draw conclusion on whether the financial statement present a true and fair view of the affairs of the company.

Auditors design audit procedures to detect all kinds of risks identified and ensure that the required audit evidence is obtained sufficiently and appropriately. Senior auditors usually approve these procedures before the audit team performs their testing. This is to make sure that all concerns or risks are addressed in the procedures. Audit procedures might be different from one client to another; and from one period to another, because internal controls over financial reporting are different from one client to another, and the control might change from time to time. With this respect, auditors are required to update audit procedures from time to time even if the same team had audited the same firm in the past.

There are five (5) basic types of audit procedures followed by auditors (internal and external) to obtain audit evidence. These procedures are analytical review, inquiry, observation, inspection, and recalculation.

Analytical review

These procedures are performed in making analysis of various concepts in order to identify unusual transactions, results or events as the basis for performing other procedures. For example, when the auditors find there is unusual loss indicated in the financial statements, they may apply relevant analysis to verify such loss by comparing the loss for that particular year with profits/losses of the previous years. The analytical procedure can be used for the types of transactions or events that occur regularly or relate with other transactions or events.

Inquiry

Auditors inquire from employees or management on any matter found in the process of auditing. Sometimes auditors may inquire about the functioning or practice of various internal controls. Audit inquiry can be used by the auditor to obtain audit evidence and/or to understand some business or accounting transactions to assist in designing and performing audit tests.

Observation

Under this procedure, auditors gather audit evidence on real time through observing as the procedures are being done. For example, an auditor may join the client team to perform stock taking at the end of the year and observe whether the way they count stocks is in the correct procedures or not. This procedure does not confirm whether all stocks are counted or not, but it confirms the correctness of the procedures involved in counting the stocks. The auditor may also make observation to confirm whether the counting was really done.

Inspection

This refers to verification or vouching of documents. This is one of the most important audit procedures, and 60% of audit work involves the inspection of documents. The auditor might examine whether the invoice issued by the client is really based on the goods received. Also whether the goods received were actually the ones ordered by the company. The auditor might also examine the payment voucher against the authority that approves the payment vouchers.

Recalculation

This procedure is normally done by re-performing the works done by the client to assess if there is any difference between the auditor's work and the client's work. For example, the auditor might reperform depreciation calculation and assess if there is any difference between auditor's calculation and client's calculation. The auditor might also perform the recalculation on monthly salary expenses prepared by the payroll by finance department to ensure that the net salaries paid to the employee are correct. It is the procedure that is used to confirm the accuracy of transaction that involves calculation.

It is important that the items in the financial position are free from material misstatements. Assets, liabilities and equity should be free from errors whether intentional or not, as these could distort the decisions of the users of such statement. Auditor should exercise profession skepticism in auditing to ensure that they are not misleading. The procedure to audit item of statement of financial position is discussed as follows:

Audit procedures for trade receivables

To audit receivable balances, the auditor has to find ways of testing the existence, completeness, accuracy, ownership and valuation of such receivables. External confirmation is among the procedures an auditor uses to verify accounts receivables. The auditor requests customers to respond directly to them to confirm what they owe. This confirms the existence of receivable, its accuracy and the right the company has over such balances.

There are two types of confirmation request;

Positive: Request a reply from customers to state whether or not they agree with the balance. This is most suitable where there are weak internal controls

Negative: Request a reply from customers to state if they do not agree with the outstanding balance. This type is appropriate when the internal controls are strong (i.e., errors are not expected).

The audit procedure on receivables include:

1. Reconcile the sum of balances on the receivable's ledger to the balance on the receivables ledger control account.
2. Ensure proper valuation of receivables by looking at the aged debtor listings. The older the debt, the higher the risk of non-payment. Check if a provision is made for debts to ensure the balance of receivable is not overstated.
3. Communication with customers should be scrutinised to determine if the debt is payable and to what amount. This is because a customer may dispute an invoice because of quality of the products which makes it difficult to collect the amount outstanding.
4. Scrutiny of board minutes to check for any resolution to write off some debts or reduce the outstanding amount so that the only amount receivable remains in the books.
5. Determine the collection period. Collection period is an indicator of recoverability of debt and efficiency of credit control. Generally, an increase in collection period indicates an increase in chances of defaulting, that is the debt going bad.
6. On a test basis, trace items outstanding on customer's accounts to the copies of tax invoice, delivery note and quotations. This provides evidence that the outstanding balance is a genuine receivable.
7. On a test basis, test recent orders from customers to the delivery notes and copies of tax invoices and to the receivable ledger to obtain evidence of completeness of balance outstanding.
8. Trace amounts paid in customers' accounts to the cash book to verify that they have actually been paid and should not be part of receivables.
9. Examine credit notes issued after a year. It is possible for a company to debit a receivable account and credit sales just before the year end, and then reverse this entry early in a new year by issuing a credit note. This is done so as to boost income and profit in the current year which is then quietly reversed in the subsequent year

Audit procedures for trade payables

In principle many of the procedures that are carried out on accounts payables balance are similar to those that are carried out on accounts receivables balances. However, the auditor will be mainly concerned about the possible understatement of payables balances:

The following are the procedures that an auditor can use to detect a payable that is missing from the financial statements:

1. Reconcile the sum of balances of individual payables to the balance on the control account. In other words, the total of payables in the statement of financial position must agrees to the detailed amounts of payable to each supplier.
2. Examine communication with suppliers and board minutes to identify any disputes or amounts which might not be paid or amounts omitted from payables ledger, but which are been claimed by suppliers or other parties, for example Legal claim.
3. Trace from purchase orders to goods received notes (GRN) to tax invoices and credit entries in suppliers' accounts and then trace backward from credit entries in suppliers account to purchases order to ensure completeness, accuracy and existence.
4. Determine the payment period. This indicates the number of days of purchases in payables. Generally, an increase in payment period indicates that the company is having difficulty making payments as they become due. By increasing the payables period, the company might begin to lose out on receiving cash discounts. This can become quite an expensive source of finance and needs some explanation.
5. Re-perform reconciliations of individual payables balances to suppliers' statements. The client has to receive regular monthly statement from suppliers for update of the outstanding amount, if such service is not available then confirm the existence, and accuracy of the outstanding amount auditor may use external confirmation procedures to request the amount due from supplier.

Audit procedures for accruals and prepayments

Prepayments and accruals are likely to be small as compared to receivables and payables, however they can be material and need to be audited. The audit procedures in that case will include:

1. Compare the amounts with those reported in the previous year. Accrual and prepayments exist because of periodic payments whose trend does not change much from one year to another. For example, if at the end of last year, the entity paid rent for six months in advance, it is probably that in the current year the same trend will continue because rent is payable at particular time of the year.
2. Scrutinise payments that are made shortly after or shortly before year end. For accruals auditor simply look for payments made just after year end as this gives indication of an outstanding balance before the year end. Similarly, for prepayments look for payments made that covers a period beyond the reporting period, as this provide evidence of services that will be provided after the year end.
3. Analytical procedures. Check if there is a significant change in expenses from one year to another which necessitated the need for accruals.
4. Obtain a letter of representation. Letter from the directors to the auditors making certain representations, for example, that all liabilities have been accounted for in the financial statements which includes accruals and prepayments.

Audit procedures for inventory

1. Inventory is one of the important areas in audit. It directly affects both the statement of financial position as a current asset and reported profit as part of costs of sales. In particular, the auditor has to check the following:
2. The quantity of the inventory. The auditor must make sure that it is properly described either it is old and therefore not saleable or there is too much inventory so that it will have to be written down to net realisable value.
3. The auditor should be satisfied that the inventory is valued in the statement of financial position at the lower of cost and net realisable value of the inventory.
4. Ownership of the inventory. Just because an item of inventory is in a store, it doesn't mean that it is owned by the client. It may be third party inventory which is being held there for a fee, or the items may have been sold but have not been delivered yet. The auditor should be satisfied that all the inventory is indeed owned by the client.

Audit procedures for bank and cash

To confirm the company's bank balance the auditor will use mainly two procedures:

Bank confirmation: This is the letter from auditor to the bank requesting the bank to confirm the bank balance. In this letter the bank will confirm the details of the account holder, the bank balance as per the date requested in the letter, details of loan arrangements and any security that the bank holds for loans advanced to the company.

Perform or re-perform the bank reconciliation: In re-performing a bank reconciliation, the auditor will have to agree with the balance as per the bank statement to the bank letter. The auditor will also confirm that the balance as per bank statement totally agrees to the client's cash book, general ledger balance and statement of financial position.

In addition to confirming the bank balance, the auditor will also confirm the cash available in hand at the audit date. To confirm the existence and accuracy of the cash balance the auditor will use cash count. Cash count may routinely be done because of the relatively high risk of theft.

Audit procedures for non-current assets

Procedures to examine non-current assets focus on confirming existence, ownership, completeness, accuracy, valuation, classification and presentation of such assets in the statement of financial position. Such procedures include:

1. Physical inspection: simple ways to check the existence of the asset is to actually see it. In addition, it allows auditors detect if the assets need to be written down because they are damaged or no longer used.
2. Check purchase invoices and cash receipts: additions of new non-current assets and disposals of old ones should be checked against invoices, receipts and minutes of the board. This is because additions will be supported by invoices, and disposals will be supported by board resolutions and cash receipts.
3. Examination of repairs and maintenance: It is important to examine the repairs and maintenance account for items of capital nature which were supposed to be recognised as non-current asset to ensure completeness.
4. Reconciliation of the carrying amounts: Reconciling the amounts in the general ledger accounts to the non-current asset register.
5. Re-performance of depreciation calculations: It is important to re-perform a sample detailed calculations of depreciation of individual assets in the asset register to confirm accuracy and proper valuation of non-current assets in the statement of financial position.
6. Check disposals: This is done to ensure that once an item is disposed, the cost of the item is removed from asset account, accumulated depreciation is removed from accumulated depreciation account, and the profit or loss on disposal is properly calculated.
7. Inspect documents of title: This confirms ownership of non-current assets.

The auditor will be interested with occurrence, completeness, accuracy, and cut-off of the items of income and expenses that are recorded in the statement of profit or loss. The understatement or overstatement of any of such item distorts the reported profit and causes the statements to be misleading. As previously stated, auditor has to maintain professional scepticism to ensure this statement is presented fairly in all material respect.

Audit procedures for purchases

To collect sufficient evidence to confirm the figure of purchases that has been incorporated in the statement of profit or loss, the auditor should perform the following procedure;

1. Trace purchases transactions recorded in the purchases ledger to the purchases orders, tax invoice and delivery notes to verify if such purchases actually occurred.
2. Perform purchases analysis to identify unusual events or transactions that might be entered into purchases account to smoothening the profit.
3. Check the completeness of purchases amount recorded by matching the purchases figures to the tax purchases orders, quotations, invoices and delivery note.
4. Perform cut-off test to see if purchases transactions are recorded in the correct accounting period. Select a sample of supplier's invoices, check the tax invoice date and trace the date to the delivery note and purchases records to ensure the cut-off transaction were correctly recorded.
5. Compare prepayments that were made to suppliers in the current year to those of the previous year to see if there is any significant differences and assess if they were properly accounted for.
6. Make examination: examine subsequent debit notes or invoice cancellation after the year end to identify if such notes or cancellationsis required to be adjusted in the current year.
7. Perform recalculation in case there is any discount, to confirm that the amount of discount have been calculated accurately and accounted for accordingly. This exercise should be extended to recalculation of tax if any.

Audit procedures for sales

Auditor will use the following procedures to gather sufficient evidence with regard to sales:

1. Trace sales transactions: recorded in the sales ledger to the customer orders, tax invoice and delivery notes to verify if such sales transactions occurred.
2. Perform sales revenue analysis: to identify unusual events or transactions that might be entered into sales account to smoothening the profit.
3. Check the completeness of sales amount: recorded by matching the sales figures to the tax invoices and delivery note.
4. Perform cut-off test: to see if sales transactions are recorded in the correct accounting period. The auditor can select a sample of invoices, check the tax invoice
5. date and trace the date with goods delivered note and sales record to ensure the cut-off transactions were properly recorded.
6. Compare prepayments from customers in the current year with those of the previous year to see if there are any significant differences and assess if they were properly accounted for.
7. Examine subsequent credit notes or invoice cancellation after the year end to identify if such notes or cancellations is required to be adjusted in the current year.
8. Perform recalculation in case there is any discount, to confirm that the amount of discount have been calculated accurately and accounted for accordingly. This exercise should be extended to recalculation of tax if any.