Auditing Teaching Material

Cooperative Auditing I, for 3rd year cooperative students
CHAPTER: ONE
1. OVER VIEW OF AN AUDITING
1.1. Definition of Auditing
The word” auditing” takes its origin from the Latin word “audire” which means “to hear”.
Auditing means an examination of the accounts book and the relative documentary evidence by an
independent and qualified person in order to ascertain the accuracy of the figure there in. however,
different authors, and professionals of different countries define auditing in different ways. But
auditing is the systematic and scientific examination of the accounts of a business for determining
accuracy and reliability of the financial position of the organization.
The American Accounting Association, committee on Basic Auditing concepts - Defined

Auditing as:
Auditing is systematic process of objectively obtaining and evaluating evidence regarding

assertions about economic actions and events to ascertain the degree of correspondence between
assertions and established criteria and communicating the results to interested users.
The important parts of this definition are:
 Systematic process: audts are structured activities that follow a logical sequence.
 Objectivity: this is the quality of the way that information is obtained and also a quality of
the person doing the audit. Essentially it means freedom from bias.
 Obtaining and evaluating evidence: this is a matter of examining the underlying support
for assertions or representations.
 Assertions about economic actions and events: this is a broad description of the subject
matter that is audited. An assertion is essentially a proposition that can be proven or
disproven.
 Degree of correspondence ... established criteria: this means an audit establishes the
conformity of assertions with specific criteria.
 Comminicating results: to be useful the results of the audit need to be communicated to
interested parties orally or in written.
By Telila E, 2014GC Page 1

1.2. Historical Development of Auditing
The origin of auditing may be traced back to the fifth century, and it was started to be practiced
simultaneously with the development of the organized system of accounting.
During the early civilization government accounting records were approved only after a public
reading, in which the account read aloud. During this period separated persons appointed to hear
matters relating to the accounts from the bookkeeper. The purpose of public reading were to
determine whether persons in office were responsibly acting, honesty, and were limited to
verification of cash receipts and payments. It was merely termed as cash audit.
The industrial revolution resulted in emergency of large business, which requires owners the use
of the service of hired managers. This marked separation of owners and managers. Thus, owners
needs auditor to protect themselves from errors and frauds committed by the management and
employees. Thus, auditing was primarily considered with detection of errors and frauds
In the 1st half of the 20th century the purpose of auditing shifted from detection of errors and frauds
to determination of whether the financial statement presents true and fair picture of financial
position, operating results, and change in the financial position of the organization under the audit.
This is due to the increased responsibility of the auditor to third parties.
As large scale of corporate entity developed rapidly in the Great Britain and United States, it
become costly and time consuming for auditors to examine each and every transactions of the
organization. Thus auditor started to carefully examine randomly selected transactions. Selection
of transactions may be based on the sampling techniques and by studying and evaluating the
internal control system of the organization.
Currently computer is being used as an auditing tool to facilitate the auditing process.
Starting from the 20th century the main purpose of auditing is determination of whether the
financial statement presents true and fair picture of the financial position of the business
organization.

Objectives of Audit
The objectives of an audit may broadly be categorized as:
1. Primary objective: Expression of independent opinion on accounts

The prime and dominant principle of audit is the examination of the accounts or statements made
by an accountable party with a view to reporting to the person to whom the account is rendered
on its truth or falsity.
2. Secondary objectives:
A) Detection and prevention of errors and mistakes – Errors and mistakes can be i)
Clerical errors (errors of omission, errors of commission, compensatory
errors, errors of duplication and trial balance errors); ii)Errors of principle
(incorrect allocation, omission of outstanding assets & liabilities, incorrect
valuation of assets); and iii) Location of errors.
B) Detection and prevention of frauds –
i) Mis-appropriation and defalcation (Embezzlement of cash, and Mis-
appropriation of goods);
ii) ii) Misrepresentation of accounts (Fraudulent or falsification of
accounts – Window dressing and secret reserves).
3. Specific objectives:
i) Cost audit (verification of cost records and examination of cost accounting

procedures); and
ii) Management audit (checking managerial functions and verification of

operational efficiency)

1.3. Importance of Auditing
Some of the importances of auditing are given below.

 Detection and prevention of errors and  Facilitates calculation of net worth and
frauds. good will of the business
 Greater reliability and authenticity.  Safeguard interest of various parties
 Up to date records are available  Settlement of insurance claim
 Required information is easily available.  Useful to compare financial performance
 Execution of decision without delay of different years
 Acceptability by the authority  Help to keep accounts vigilant
 Professional advices are available  Identifies the weak area of the busines
 Settlement of dispute
1.4. Scope of Audit
The scope of an audit is dependent upon:

 The terms of agreement between the auditor and the client
 Statutory requirements
 Requirements of relevant professional bodies
Although an auditor’s report is usually appended to a balance sheet audit work cover wider
grounds and includes the checking of the profit and loss account or income and expenditure
account and ledger accounts, and also scrutiny of entities with original documentary evidence so
as to establish without doubt that not only accounts are arithmetically correct but also transactions
are duly authorized and are consistent with the general nature of activities. Audit enables an
auditor to express opinion on financial statements and establishes credibility thereof. Sometimes
audit may be restricted to a special financial or statistical statements relating to prospectus or
statutory report of accompany, net circulation of a news paper, production of account cost
accounts, etc. The sphere of auditing has been expended beyond financial records and statements
and now covers cost records, operations/performance, propriety, social and environmental
implications, etc

1.5. Accounting vs. Auditing
Accounting is the process of recording, classifying, summarizing, analyzing, and interpreting the
financial (money related) activities of the business and communicating the results there into the
stockholders. However, auditing involves a detailed and critical examination and verification of
accounts by an independent expert for the purpose of ascertaining the true and fair position of the
financial activities of the business. In other words, the end result of accounting concerned with
preparation and interpretation of the financial statement. Whereas, the end result of auditing
entails preparation and submission of audit report.
Similarity
 Both accounting and auditing are concerned with accounting information
 accountants and auditor has to have considerable expertise in accounting maters
Major difference
In Methodology:-
Accounting- adheres in analyzing, recording classifying and summarizing
Events and transactions to prepare financial statements
Auditing – obtain and evaluate evidence covering financial statements
 In objective :-
Accounting – objective is prepare finical statements as per GAAP and provide report to
management.
Auditing – determine farness of statements in conformity with GAAP and Prepare audit report
in conformity with Generally Accepted Auditing Standards
1.2.2. Types of Audit
There are different types of audits based on different reference. These are based on time period,
nature and legal basis of audit.
Based on nature audit, it’s classified as:
a. Operational Audit: - it is the review of any part of the organizations operating procedures
and methods for the purpose of the evaluating the efficiency and effectiveness of organizational
performance of the business origination. In other words, it deals with the determination of

whether the objectives of the entity are attained within the established standard. At the completion
of the operational audit, recommendations to management for improving operations normally
expected.
b. Compliance Audit: - The purpose of compliance audit is to determine whether the accountant
is following the specific procedures and rules set dawn by some higher authority. Compliance
audit for private business could include determining whether accounting personnel are following
the procedures prescribed by the company controller.
c. Financial statement Audit: - is conducted to determine whether the overall financial

statements being verified are stated in accordance with specific criteria. Normally, the criteria are
generally accepted accounting principles. The financial statement audit mostly includes; statement
of financial position, income statement, and statement of cash flows, etc
d. Environment Audit: - this type of audit is not this much applicable in our country. But in
developed countries and India which need consent or authoritarian under the air, water and
environment pollution acts, are required to affect environmental audit for every year ending.
Every such industry must submit the report to the concerned pollution control board. The report
should specify the amount of pollutants and wastes (hazardous as well as solid) and indicates
disposal practices adopted for both, wastes generated from process, pollution control and quantity
reduced or reutilized, impact of pollution control, measures on conservation of national resources,
cost of production, investment proposals for environment protection, etc.
Environmental audit for industrial or commercial establishment refers to checking of the

effectiveness or otherwise systems or measures adopted for prevention or minimization of solid,
air and water pollutions. The objective of such audit is to ensure fulfillment by an undertaking of
obligations relating to protection of environment. Environmental auditor may be internal or
external. The report highlights strength and weakness. (Vulnerability of the various systems)
measures for protection against risks of environmental pollutions and suggestions on the
appropriate follow- up actions are to be submitted periodically.
e. Systems Audit: Accounting methods and office procedures may require periodical review and
reorientation so as to be up to date and of maximize use to management. There appears to be a
growing practices on the part of many organizations to appoint auditors or other experts to

examine their accounting systems and other operational methods including internal control and
internal check systems and, if necessary, to recommend improved systems that are up to date,
efficient and economical including computer based systems and electronic data processing. This is
known as system audit which is now days considered a useful tool of internal control.
With the rapid growth and spread of information technology, related management systems and
controls, professional accountants must upgrade their knowledge to master the rules of auditing in
informational technology environments.
f. Social Audit: “Social audit” may be defined as a kind of audit aimed at verifying and
reporting on the extent of fulfillment by an organization (as organization of a society) of its
obligations to the society in different directions. In other words, the object of social audit is a
social object of finding out what contributions an enterprise (which has diverse obligations to the
society) makes, and what it takes from others, and ensuring that social or public interest is sub
served. Such audit has to be carried on by independent persons.
Even though no standard or widely accepted procedure for social audit has yet been devises the
following principal factors have emerged as a vital components of a special system for assessing
social performance of organizations covering benefit and costs to social by reference to both
quantum and money value of their various actions and operations.
 Contribution to national economic growth through expansion, employment generation, wider
ownership pattern etc,
 Relation with people including cordial industrial relations, training and employment in general
and in particular, of handicapped, back ward and minority people employee welfare
 Product relation including quantity, quality, safety and prices of products supplied or services
rendered
 Environmental relations including improvement of or detriment to environment or ecology,
control of environment pollution of different kinds.
 Quality of life including social, family and community welfare schemes, employees self
reliance and self dignity schemes like cooperatives of different kinds, promotion of education,
community development, rural up-liftment including adoption of villages, up keep of Gardens and
parks, etc.
 Social or national development e.g. promotion of sports, music and games, art and culture, etc.

Enable assessment of money value of social contributions of an enterprise, specially designed

accounting systems have been on are being involved to show various social costs and benefits in
monetary terms of social performances as state above. Benefits and costs to employees,
community general public are ascertained and social balance sheet is prepared comprising
contributions by public ( equity) and employees, on the one hand and social investments and
assets, human assets , on the other social audit would involve checking of the said social accounts
and social performances and stated in the directors’ reports or in other documents.
Social audit would enable business managers to keep in mind their social obligations.
Based on time period reference
a. Final audit, it is a statutory annual audit of an organization
It is a complete audit for the year
b. Partial or Interim Audit: such audit is applied to certain business entities and
conducted between one final audit and the other. Such audit is mainly to check the
financial transactions in order minimizes the work of the final audit
c. Concurrent Audit: this kind of auditing engaged continuously throughout the year
The auditors attend to his work at frequent intervals
Such auditing is made in big company where there are huge transactions.
Based on legal basis of audit

a. Statutory audit: When the audit of an organization is compulsory and statute, it is said to
be a statutory audit.
a. Non Statutory audit
Types of auditors
Auditors can be classified according to their employment status. Accordingly there are two
groups of auditors.
1. External auditors (certified public accountants, chartered certified accountants) are third
party contractors more often hired by an organization to perform a financial audit of the
organization’s financial statements. Commonly referred to as independent auditors (in the
sense they have no financial interest in the organizations they audit).

2. Internal auditors: they are an employee of the organization in which they work. Their
independence is derived from their organizational status in terms of official they report to.
Traditionally, external auditors performed the financial audit and the internal auditors
did the operational and compliance audits. However, the clear distinction in duties
between internal and external auditors has become blurred as more internal auditing
departments have been out sourced.
Generally Accepted Auditing Standards (GAAS)

The task of planning, conducting, and reporting of the audit results should be made in accordance with
generally accepted auditing standards (GAAS). Auditing standards provide a measure of audit quality
and the objectives to be achieved in an audit. Auditing procedures differ from auditing standards.
Auditing procedures are acts that the auditor performs during the course of an audit to comply with
auditing standards.
Auditing Standards
According to AICPA there are ten audit standards which are grouped into three broad
categories that one auditor should see himself and check his audit work during the course of
auditing.
A. General Standards
1. The auditor must have adequate technical training and proficiency to perform the audit.
2. The auditor must maintain independence in mental attitude in all matters relating to the
audit.
3. The auditor must exercise due professional care in the performance of the audit and the
preparation of the report.
B. Standards of Field Work
1. The auditor must adequately plan the work and must properly supervise any assistants.
2. The auditor must obtain a sufficient understanding of the entity and its environment,
including its internal control, to assess the risk of material misstatement of the financial
statements whether due to error or fraud, and to design the nature, timing, and extent of
further audit procedures.
3. The auditor must obtain sufficient appropriate audit evidence by performing audit
procedures to afford a reasonable basis for an opinion regarding the financial statements

under audit.
C. Standards of Reporting
1. The auditor must state in the auditor's report whether the financial statements are
presented in accordance with generally accepted accounting principles (GAAP)
2. The auditor must identify in the auditor's report those circumstances in which such
principles have not been consistently observed in the current period in relation to the
preceding period.
3. When the auditor determines that informative disclosures are not reasonably adequate,
the auditor must so state in the auditor's report.
4. The auditor must either express an opinion regarding the financial statements, taken as a
whole, or state that an opinion cannot be expressed, in the auditor's report. When the
auditor cannot express an overall opinion, the auditor should state the reasons therefore in
the auditor's report. In all cases where an auditor's name is associated with financial
statements, the auditor should clearly indicate the character of the auditor's work, if any,
and the degree of responsibility the auditor is taking, in the auditor's report.
1.2.4. Comparison of financial statement audit with non financial audit
 Performance and Financial Statement Audit

The financial statement audit is confined to examine the validity of appropriation or is concerned
with verifying that there is no leakage of revenues and wastage of funds knowingly or
unknowingly in disregard of any legal requirement or financial or economic consideration. While
performance audit is a procedure for analyzing the profits and losses of economic activities carried
on by the business enterprise examining the relationship b/n the production and sales and
discovering the revenue for maximizing the profits.
Both the financial statement and performance audits are interrelated. The management of the
company is expected to guarantee the propriety and validity of all transaction and the financial
statement audit has to certify them. Similarly, the performance audit has to evaluate the
performance of the management. Thus, both audits are meant to cove examination of the propriety
aspect of transactions as well as the review of operational aspect of a company. In general,
financial audit and performance audit compare as follows:
 Financial audit is an intelligent and critical scrutiny of books of account with documents and
vouchers to ascertain that:
o Profit and loss accounts give a true and fair view of working result for the year.
o Balance sheet gives true and fair view of the financial position of an organization. While,
management audit is undertaken to ascertain efficiency of the performance of the management.
 Financial audit is confined to examination of historical records of past performance. While,
management audit appraise past and simultaneously make a future oriented approach.
 Performance auditor’s work begins where the financial auditor ends.
 Financial audit primarily concerned with financial aspect. And management audit involves
critical examination of organizational structure, manufacturing process, production planning, and
scheduling, etc.
 Financial audit is a statutory obligation, while, management audit is an optional exercise.
 Area and scope of management audit is very wide and comprehensive, which is not in the
financial audit.
 Comparison of Financial statement audit and other Types of audit
Similarity of Financial statement audit and other types of audit

Regardless of the different types of audits that are carried out, all audits possess certain general
characteristics some of which are listed her below:

i. They all involve systematic examination and evaluation of evidence so as to ascertain whether
financial statement or actions or actions of organizations comply with established criteria.
ii. The results of the examination communicated by a way of written report to the party by whom
or on whose behalf the auditor has been appointed
iii. Personals assigned to carry out the examination must be issued with an engagement latter by
the appropriate organizations.
iv. There is always a time frame with in which the work must be accomplished and also term of
reference.
Difference between Financial statement audits and other types of Audit
Financial statements Audit other types of Audit
- The examination carried out by a - the examination must be
qualified auditor who must be certified. carried out by an expert
- The auditor appointed by share holder or and not necessarily an auditor
on their behalf by the board of directors - The expert whether an auditor
- Person appointed to carry out the independent or not is appointed by the mgt.
(external) of the enterprise - The person appointed to carryout
- The report on the findings is addressed to the examination may be internal
shareholders. or external
- Remuneration (pay) of the auditor determined - the report on the findings is
by the shareholders addressed to the mgt.
- Remuneration of the expert or
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auditor determined by the

management
1.2.3. Internal Vs. External Audit
Internal audit is an audit conducted by an internal auditor appointed by the management of the
enterprise with the view of highlighting the weak areas of the organization. Internal audit is the
independent appraisal activity with an organization for the review of the accounting, financial, and
other operation as a basis for protective and constructive service to the management. It is the type
of control which functions by measuring and evaluating the effectiveness of the other types of the
control. It deals primarily with accounting and financial matters, but it may also properly deals

with the matters of the operating nature. Internal auditing includes examination and evaluation of
various organizational activities and producing the helping hand to the management to complete
their responsibilities efficiently and effectively.
The internal auditor audits the accounts and the relevant records daily, regularly, or on periodical
basis for the following purposes;
 To ascertain whether all rules, regulations, procedures, and principles have been followed by the
company or not.
 To check whether the existing internal control system is adequate and effective with the size of
the business.
 To ensure that all assets of the organization are properly safeguarded
 To highlight the weak areas of the organization and give suggestions.
 To check whether the working of the organization is smooth, effective, and economical.
External audit is an audit is an audit conducted by an external auditor appointed under statutes by
owner. It is closely identical with internal audit in respect of:
 Evaluation and improvement of internal control system.
 Ascertainment of adequacy and effectiveness of the accounting system, so that the output is
fairly reliable.
 Means of examination.
External audit is different from internal audits. The points of distinction are;
Internal audits under take when an enterprise convinced of its utility in terms of the benefit
offered and costs involved, where as external audit undertaken in case of enterprises which are
under the statutory obligation to have their accounts audited.
The responsibility of internal audit is primarily for management, while responsibility of
external audit is primarily for owner and in case it also extends to interested third parties, etc.
CHAPTER TWO
3. PROFESSIONAL ETHICS AND LIABILITEIS OF AUDITOR

3.1. Auditors code of professional Ethics
3.1.1. Meaning of professional ethics

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Ethics: represent a set of moral principles, rules of conduct or values. Each of us has such a set of
values. Examples of prescribed sets of moral principles or value include laws and regulations,
church doctrine, codes of business ethics, code of conduct with individual, organizations, etc.
Ethics apply when an individual has to make a decision from various alternatives regarding
moral principles. All recognized professions have developed codes of professional ethics. By
establishing a code of ethics, a profession assumes self-discipline beyond the requirements of the
law. It constitutes self imposed rules to the practices.
3.1.2. Fundamental Ethical principles and guidelines for the Audit Profession
To achieve the objectives of the auditing profession, professional auditors have to observe a
number of perquisites or fundamental principles. The fundamental principles are
1. Professional competence and technical standard

Professional competency is concerned with the quality of the auditor. An auditor must be
professionally qualified to understand the criteria used, to know the type, and amount of evidence
to accumulate and to reach the proper conclusion, while, technical standard is concerned with the
ability to act / perform audit activities based on technical standards. That means the ability to
identify the misstatements, in consistency of accounting principles, etc.
2. Integrity
Integrity is the core value of a code of ethics. Auditors have a duty to adhere to high standard of
behavior in the course of their work and in their relationships with the staff of auditor entity
members is expected to be straight forward, honesty and sincere in his approach to professional
work . In order to maintain public confidence, auditor shall exercise a high level of integrity.
Integrity can be measured in terms of what is right and just.
3. Independence.
A certified public accountant in public practice shall be independent in the performance of
professional service. Independence in auditing is taking an unbiased viewpoint in the performance
of audit tests, evaluation of the results, and the issuance of the audit report.
Independence must certainly be regarded as the auditor’s most critical characteristics. The reason
is that users are willing to rely up on the reports as to the fairness of financial statement because of
their expectation of unbiased view point / attitude.
4. Confidentiality

As a profession auditors should respect the confidentiality of information acquired in the course of
his work and should not disclose any such information to a third party without any specific
authority or unless there is a legal or professional duty to disclose.
 In performing an audit, the auditors have access to the details of the client’s most confidential
information. If the auditors disclose this information, they may damage the clients business.
Therefore auditors are required to maintain a strict confidentiality relationship with their clients.
 Information confidential to a client or employer acquired in the course of professional work
should not be disclosed except where consent has been obtained from the client, employer or other
proper source, where there is a public duty to disclose or where there is legal or professional
right/duty to disclose confidentiality information may include:
- Impending business combination
- Proposed financing
- Contract being negotiated
- Prospective stock split or dividend changed.
 A member acquiring information in the course of professional work should neither use nor
appear to use that information for his personal advantage or for advantage of third party. Where a
member is in any doubt the matter, if appropriate, should initially disclose fully with in his firm. If
not appropriate, or if it fails to resolve the problem, he should consider taking legal advice and/or
consult the association.
5. Ethical behavior
Ethical behavior is necessary for a society to function in an orderly manner. It can be argued that
ethical behavior is the glue that holds a society together. It is important to understand what causes
people to act in a manner that we decide is unethical.
Most people define unethical behavior as conduct which differs from what they believe. There are
two primary reasons why people act unethically, one the person’s ethical standards are different
than those of society as a whole, and second the person chooses to act selfishly.
3.2. Auditors professional Responsibility and liability
3.2.1. Auditors Professional Responsibility

Auditors have primary responsibility to serve the society. To this end, auditors shall be able to
have responsibility;
 Better communication skill: - auditors should communicate to users the result obtained and the
character and limitations of an audit.
 Detection of errors and irregularities: - the auditor is required to design the audit to provide
reasonable assurance of detecting errors and irregularities that tare material to the financial
statement.
 The term error refers to unintentional misstatement or omissions in financial statements, such as
mistakes in gathering and processing of data, incorrect accounting estimates and mistakes in the
application of accounting principles. Errors classified as: omission errors; errors occurred when
any transaction omitted to be recorded in a book of original entry. Commission or clerical errors;
errors when transactions are incorrectly recorded. E.g. Wrong posting of an item on debit and
credit. Errors of principle; is when any transaction is recorded in violation of fundamental
principles of account. Compensating errors; is when one or more errors being counter balanced by
one or more errors. Duplication errors; it arises when an entry in a book of original entry
transaction made twice and has also been posted twice.
 The term irregularities refer to intentional misstatements or omissions in financial statement.
 Detection of illegal client acts: - the auditor should design the audit to detect the illegal acts. An
illegal act refers to such act at the payment of bribes, the making of the illegal political
contribution and the violation of other specific always and governmental regulations. When
irregularities or illegal acts having material effect on financial statements are not properly
accounted, the auditor should express a qualified opinion or an adverse opinion because the
financial statements are not inconformity with GAAPS.
 Reporting doubts as to an entity’s ability to continue as a going concern:- the auditor has a
responsibility to evaluate and disclose whether there is substantial
Doubt about the entity’s ability to continue as a going concern for a reasonable period of time.
3.2.3. Auditors Liability
1. Auditors’ liability to third party

The third party is an individual who is not in privities with the parties to a contract privities refer
the existence of direct relationship between parties through a contract. Third parties can be
classified as primary beneficiary and other or general third beneficiaries. A primary beneficiary is
one about whom the auditor was informed prior to conducting the audit. Those third parties their
existence is not known are referred to as general third beneficiary. The auditor is liable to general
third parties for gross negligence and fraud.
2. Auditors’ liability to the public

The auditor is responsible for every aspect of his or her public accounting work including
auditing, taxes, mgt advisory services, and accounting and bookkeeping services.
Liability for professional negligence

Negligence means breach of duty to take care. Auditor is required to exercise reasonable care and
skill in the performance of the auditing task.
Criminal liabilities
Crime means any offence punishable by law. Criminal liability of an auditor arises out of all
illegal act resorted to crime. When an auditor willfully makes a false statement in any report,
certificate example balance sheet etc destroys or mutilates any document, he may be held
criminally liable.
Criminal liability of an auditor basically arises because of offence against the statutory to the
client, but also to the state.
Therefore, criminal liability arises from errors in the performance of audit duties involving
criminal neglect or, of course, actual fraud or conspiracy in which intention to do what is known
to be illegal. If an auditor is held guilty of criminal misconduct, he shall be punishable with fine or
imprisonment or both as might be provided is the relevant etc
CHAPTER THREE

Audit Evidence and Its Documentation
2.1.1. Meaning, Source and Types of Audit Evidence
Audit evidence is the information obtained by the auditor in the documentary form or oral or in
a visible manner from and / or within the business unit or outside. The correctness,
appropriateness, adequacy, and reliability of such audit evidence aid the auditor to draw
reasonable conclusion about the accounting practice and financial information of the business
audited.
Source and types of audit evidence
Source of Audit Evidence: - there are different sources of audit evidence from which auditors
can generate conclusion and prepare audit report. These includes’ accounting system,
documentary evidence, tangible asset management and staff, client’s customer and third parties
who have knowledge of dealing with the client.
a) Documentary Evidence: - these types of audit evidence are also known as primary evidence. It
comprises of evidence obtained from the entity’s own records and documents and as such forms
an internal source of audit evidence in regard to:
i. Accuracy of accounting records
ii. Authority of accounting records
iii. Accuracy of the balances from the ledger
b) Tangible Assets- tangible asset will provide evidence regarding the accuracy of balance sheet
entries, strength of internal control system, ownership, existence and valuation of the assets.
c) Hearsay evidence: - refers to evidence obtained from sources such as interviews, conversations
with mgt/ staff or from questionnaires. Such evidence is not concrete but can provide links for
further investigations / follow – ups
d) Management and employees:- mgt and employee can provide evidence about:
 The strength and weakens of the policy
 The operational efficiency and mgt
Classification of Audit Evidence

Audit evidence may be classified on the following basis:

 Source of evidence: external and internal
 Mode of evidence: oral and documentary
 Nature of evidence visible and non visible
The auditor can gain increased assurance when audit evidence from different sources and different
nature is consistent. The evidence must be both valid and relevant. In cases of inconsistency
further procedures are to be adopted to solve the inconsistency
2.1.2. Attributes of Audit evidence
We have earlier mentioned the appropriateness of audit evidence (quality of audit evidence).
These attributes refer to certain factors which the auditor must consider while collecting audit
evidence. Some of this attributes are:
1. Relevance
Relevance refers to how closely the evidence at hand relates to the particular objective that the
auditor would like to fulfill. Evidence is relevant if it has a logical relationship with, and
importance to, the issue being addressed.
2. Reliability
Reliability refers to how confident the auditor is that the evidence at hand reflects the facts of the
manner being investigated. Reliability of audit evidence depends up on the particular
circumstances; the following presumptions are useful in judging the reliability of evidence.
However, the presumptions are not to be considered sufficient in themselves to determine
reliability. The amount and kind of evidence required to support auditors conclusion should be
based on the auditor’s professional judgment.
a. Evidence obtained from external source is more reliable than that obtained from the entity. In
assessing the reliability of evidence, auditors should consider such factors as whether the evidence
is accurate, authoritative, timely, and authentic.
b. Evidence obtained from the client record is more reliable where the accounting and internal
control system operates effectively. Evidence obtained when internal controls are effective is
more reliable than evidence obtained when controls are weak or nonexistent. Auditors should be

particularly careful incase where controls are weak or nonexistent and should, therefore, plan
alternative audit procedures to corroborate such evidence.
c. Evidence obtained directly by auditors through physical examination, observation,
computation, and inspection is more persuasive than information obtained indirectly, or second
hand. ”show me not tell me”
d. Documentary evidence is more reliable than oral evidence.
e. The original evidence is more reliable than the photocopy.
3. Availability
This has refers to how readily the auditor can obtain the evidence that he requires
4. Timeliness
This reference to how quickly the desired evidence can be obtained by keeping their time
sequence. There is certain evidence which the auditor may be aware of
5. Cost
The cost of obtaining particular evidence should be weighed against the benefits derived from
such evidence.
Sufficient and Appropriate Audit Evidence
Sufficiency and appropriateness are interrelated and apply to the evidence obtained from both
compliance and substantive procedures. Sufficiency is the measure of the quantity of audit
evidence obtained; the auditor finds it necessary to rely on evidence that is persuasive rather than
conclusive.
The auditor’s judgment as to what is sufficient and appropriate audit evidence is influence by:
 The degree of risk of misstatement.
 The materiality of the item in relation to the financial information taken as a whole.
 The experience gained during previous audits.
 The types of information available
Methods of Obtaining Audit Evidence
Audit evidence is obtained through one or more of the following techniques of
audit testing.
Inspection consists of reviewing or examining records and documents,
physical verification of tangible assets.

Documentary evidence may be classified into the following categories:

1. Documents originating from sources outside the entity but held in the
custody of the client e.g. purchase invoice, insurance policies etc. These
documents are generally reliable as audit evidences for the transactions
represented by them. But there are variations as to the degree of
reliability depending upon the possibility of forgery and alteration.
2. Documents prepared inside the entity under audit; but validated by
independent sources. E.g. checks.
3. Documents created and held by the entity (and used completely within
the entity) under audit. These are considered generally of lesser
reliability; but if subjected to strong internal control they may
nevertheless be quite reliable. Physical inspection of tangible assets
provides tangible evidence with respect to their existence but not
necessarily as to their ownership or valuation expressed in monetary
terms.
Observation is looking at an operation or a process or a procedure being
performed by others with a view to determining the manner of its performance.
E.g. the auditor may observe the counting of inventories by client personnel.
Observation provides reliable evidence as to the manner of the performance at
the time of observation, but not at any other time.
Inquire and Confirmation consists of seeking relevant information from
knowledgeable persons inside or outside the entity. Enquiries range from
formal written enquiries addressed to persons outside the entity to informal
oral enquiries addressed to persons within the entity. Responses to enquiries
may provide the auditor with new or corroborative evidence.
Computation consists of checking the arithmetical accuracy of source
documents and accounting records or performing independent calculations.
Independent calculations made by the auditor often provide an important
source of audit evidence.

Analytical review this consists of studying significant ratios, trends and

other statistics and investigating unusual or unexpected fluctuations as well as
items and expected fluctuations which fail to occur. Various ratio and trend
analysis are recognized as important audit tools.
2.1.3. Audit Assertions (financial statement assertation)

Most of the independent auditors work in forming his opinion on financial statements consists of
obtaining and evaluating matters concerning the assertions in such statement. Assertions are
implied or expressed representations about the accounts in the financial statements and are
directly related to generally accept accounting principles. This assertion includes;
Occurrence – the transactions actually took place
Accuracy – the amounts are correct
Cut-off – transactions are accounted for in the correct period
Classification – transactions are recorded in the proper accounts
Existence – the assets or liabilities actually exist
Rights and obligations – the client owns or has other rights over the assets
and has a genuine obligation to pay liabilities
Valuation – assets or liabilities are included at appropriate amounts
Allocation – account balances are included in appropriate accounts
Classification and understandability – items in the financial statements are
disclosed under appropriate headings and in such a way that they can be
readily understood by readers.
2.2. Documentation of Audit Working Paper

2.2.1. Meaning and Objectives of Audit Working Paper
Meaning of Audit Working Paper
Audit working papers are the records kept by the auditor of the procedures applied, the tests
performed, the information obtained, and the pertinent conclusions reached in the engagement.
Objectives of audit working papers
 The overall objective of working papers is to aid the auditor in providing reasonable
assurance that an adequate audit was conducted in accordance with generally accepted
auditing standards.

 More specifically, working papers of a particular year’s audit provide:

1. A basis for planning and performance of the audit
2. A record of the evidence accumulated and the results of the tests
3. Data for determining the proper type of audit report
4. A basis for review by superiors
5. Evidence that the audit was conducted in accordance with ISAs and legal and
regulatory requirements
6. Aid the auditors defense if subsequently sued for negligence
There are two major principles that need to be adhered to in preparation of working papers:
 If it is not recorded, it did not happen
1. If there is nothing on file, there is no evidence that the necessary procedures were
completed, so there can be no basis for the audit opinion.
 If it can’t be understood, it might as well not have happened
1. Clarity is important for two reasons
2. Completeness – if the working papers are easy to understand it will be more
obvious if anything has been omitted.
3. Efficiency – clear working papers will keep the time spent and then the audit
costs to a minimum.
In order to achieve the above objectives, the working papers should provide:
 A means of controlling the current year’s work and the basis on which to plan the
following year’s audit;
 Evidence of the detailed work carried out and conclusions drawn on various sections of
the work;
 Schedules and analysis in support of the accounts additional to, or summarizing, the
details in the books of accounts;
 Summary of significant points affecting the financial statements and the audit report,
showing how theses points were dealt with;
 Information concerning the legal and organizational structure of the auditee.
2.2.2. Form and contents of Audit working paper

The auditor’s judgment about the quantity, form and content of working papers should be guided
by the following factors:
 The nature and complexity of the business.
 Accounting practice and procedures used.
 The business internal control system.
 The form in which audit report prepared.
Content: - Working papers normally includes;
 Audit program
 Audit note book: it may not be possible for an auditor to bear in mind all the difficulties that
may arise during the course of an audit or the points which s/he wants to consult with the
concerned people. As a result s/he maintains audit note book.
 Copies of the document which the auditor has taken
 Schedules of debtor and creditor, fixed assets, investments
 The certificate of the stock in trade and its valuation
 Copies of the correspondence concerning the audit work
 Contract latter from the clients
 Particulars of depreciation and investment
 Copies of the previous audit report
 Copies of the resolution passed in the meetings of stockholders and directors
 Certificate from the management that all the outstanding assets and liabilities have come under
the accounts
 Details of the question made during the course of audit and their explanation given
 Other necessary papers required
2.2.3. Audit File
Record of audit is maintained in files known as audit files. Audit files vary depending on the
circumstances of the audit and personnel preference of the auditor. However, there are two broads
of files:
Permanent Audit File:- it includes those working papers which are useful in conducting the audit
examination year after year.

Permanent audit file includes:

 Name, address and telephone number of the client.
 Brief descriptions of the business and its operation.
 Plan of the office lay- out of the client.
 Copies or excerpts of the memorandum and articles.
 Organization and authority responsibility structure.
 List of the person authorized to sign cheques, contracts, and major documents
 List of document, books records and procedure manuals covering all phases of operation.
 Details of operation.
 Auditor’s analysis of accounts which have little or no change like land, building etc.
Current Audit File: - it contains papers and information obtained or developed during the current
audit. At the end of audit items of continuing interest are transferred to the permanent audit file.
The contents vary according to the types of the business. But it generally comprises;
List of items to be reviewed.
Internal control questionnaires.
Audit program
Bank reconciliation, financial statement, trial balance, audit adjustment, etc.
2.3. Letter of Engagement

An engagement letter is written contract between an auditor and client. It generally serves to
minimize misunderstandings, and alert the clients to the purpose of the engagement and the role of
the external auditor and used to minimize legal liability.
Contents of Engagement Letter

1. The objective of the audit of financial information.
2. Management's responsibility for the financial information.
3. The scope of the audit, including reference to applicable legislation, regulations, or
pronouncements of professional bodies to which the auditor adheres.
4. The form of any reports or other communication of results of the engagement.
5. The fact that because of the test nature and other inherent limitations of an audit, together with
the inherent limitations of any system of internal control, there is an unavoidable risk that even
some material misstatement may remain undiscovered.

6. Unrestricted access to whatever records, documentation and other information requested in

connection with the audit.
2.4. Representation by Management
It is now normal audit practice for the auditor to obtain a letter from a management addressed to
the auditor confirming any representation given by the management.
Documentation of Representation by Management
Auditor obtains numerous representations from management like managements oral and written
representations. For example, oral representation includes; inquires about errors, irregularities, and
related parties. Written representation includes; journal, ledgers, and other documentations.
Although written representations are tangible, oral representations are not, thereby requiring that
an auditor obtain a management representation latter documenting management’s most significant
representations.
The letter should be signed by appropriate members of management, normally the chief executive
officer and the chief financial officer, and should specifically state managements understanding
that;
1. Financial statements are managements representations and primary responsibility, and
2. The auditors relied up on managements representations in forming an opinion on the financial
statements.
Content of Management Representation

I. Management’s acknowledgement.
II. Availability of all financial records and related data’s
III. Completeness and reliability of all minutes of meeting of stockholders, directors, and
committees of directors.
IV. Absence of errors in financial statements and unrecorded transactions.
V. Information concerning related party transactions and related amount receivable an payable
VI. Information concerning subsequent events
VII. Irregularities involving management or employees.
VIII.Plans or intentions that may affect the carrying value or classification of assets or liabilities.

A management representation letter is critical to an audit, if management refuse to give a written

representation, the auditor would issue unqualified opinion to disclaimer audit of opinion.
CHAPTER FOUR
4. Audit Planning
4.1. Importance and steps of Audit planning
4.1.1. Meaning of Audit planning

Planning is an essential element in the audit process to optimum utilization of resources and
efforts. Planning is not simply a process of scheduling a set of mechanistic audit operations. It
involves in general establishing objective, understanding systems, prioritizing the audit works,
including extent of work (deciding on the auditable activity or area based on risk assessment),
determining resource allocation and other issues.
The responsibility of planning audit lies with the head of audit department. Audit plan should be
revised as and when necessary.
Advantage of Audit Planning

 Helps to define the objectives and the scope of the audit
 Provide base for allocating adequate resources in terms of human and other resources.
 Provides base line for assessing, monitoring and controlling the progress of each audit
 Enable the audit to be carried out more efficiently, effectively and timely
 This enables an auditor to organize the different aspects of audit work including vouching,
verification, valuation, expression of opinion on financial statement and submission of
auditor’s report in a systematic and mechanical manner.
 Audit planning helps in enhancing the quality of audit work.
 Satisfactory audit planning is important to establish the right means to achieve the
objective of audit, ensure that appropriate attention is paid to important areas of
management, assists coordinating the work done by auditors and express, etc.
4.1.2. Factors affecting the extent of Audit planning.

The auditor should plan to conduct an effective audit in an efficient and timely manner. To this
end, audit plan should be based procedures, the extent to which internal control system may be
relied up on, determination of appropriate audit procedures and coordination of work.
In general, the following factors should be considered while planning audit;
 Complexity of audit (size or operational complexity of business)
 Environment in which the entity operates.
 Previous experience with the client
 Knowledge of the clients business, etc.
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4.1.3. Preliminary Arrangements for Audit planning,

Preparation before audit plan refers to preliminary arrangements by the auditor with regard to
audit planning. An auditor must prepare well before he actually conduct audit plan. Preliminary
arrangement of audit plan, mostly based on the client’s knowledge about the business. It is most
important as this will help the auditor to identify the events, transactions and a practice that is in
his judgment, may have a significant effect on the financial information. Such knowledge of the
business can be obtained from;
 annual audit reports to shareholders

 Past performance
 Overall performance
 Expected performance
 Problems encountered leading to non- attainment of goals etc
 Minutes of meeting of the Board of Directors:- by using the above minutes, an auditor may
obtain the information such as:
 Authorized capital expenditure
 Proposed Dividends
 Sale and acquisition of fixed Assets
 Acquisition of long term loans etc.
 Other committees like investment, budget, audit committee etc.

From such minutes, the auditor may obtain information on the client’s budgetary policy and
any problems that may have impeded such policies.
 Previous year’s audit working paper
These contain information on the client’s financial position, the strengths or other wise of the
ICS, Areas where frauds were detected on above all. Areas where the auditor may not have
received maximum cooperation from the client.
 Discussion with client: An auditor may also conduct interviews with responsible personnel
from the client’s organization. From such interviews, he may obtain information such as:
 Efficiency of the client’s general administration and overall performance.
 Current market situation of the client in the industry
 The achievements of the client and also his failure to date.
 Manuals about client’s policy and procedure
 Relevant publications of the client ( trade journal, magazine, financial management report, etc)
The auditor should look at the previous reports as well as the current ones. He may, be able to
establish whether the client’s financial position and objectives are consistent. He will also
establish previous performance and any deviations that need to be explained.
 Visit to the clients premise and Facilities
The auditor will be able to obtain information regarding:
o Size of the client organization and implications for the audit
o Accounting systems and their adequacy
o Nature of the Company’s products and product lines
o Trading operations

4.1.4. Development of an overall Audit plan
An audit plan will not only help the auditor to understand the expected scope of audit (area of
operation), but also facilitates audit activity. The auditor should consider the under mentioned
matter while developing the overall audit plan.
 Terms of engagement and statutory requirements.
 Nature and timing of reports
 Accounting policies adapted
 Identification of significant audit area
 Nature and extent of audit evidence
 The work of internal auditor
 Conditions requiring special attention.
4.2. Audit Program

An audit program is a written scheme / schedule of the exact details of the work to be done by the
auditor and his/her staff in connection with a particular audit. The auditor should prepare a written
audit program setting forth the procedure that is needed to implement audit plan. It is the auditor’s
plan of action.
The plan also indicates the distribution of audit work to the audit staff giving deadlines for their
completion
4.2.1. Importance and Disadvantages of Audit Program
The major importances of audit program are;

 Basic instrument to train audit staff and used as guide for performance of audit activities.
 Progress of work examined periodically
 Uniformity in performance can be ensured.
 Responsibility for negligence fixed
 Used for supervising the work of the staff
 Save time and assure adherence of to the principles of auditing.
Disadvantage of Audit program

Even though audit program have numerous importance, it suffers still from certain limitations.
Some of the common limitation of audit program is;
 Auditor’s task become mechanical and auditor’s may lose interest and initiative
 Audit program may not be complete and certain items may left form being checked.
 The periods and records required to be tested may not be varies systematically
 Procedures adopted may not be suitable or appropriate to circumstances of the client.
 No rigid audit program can be laid down for each type of audit work.
4.2.2. Preparation of Audit program
Audit program must be developed with due care and skill. In drawing up satisfactory audit
program the auditor should consider the following.
 Ascertaining exact duties of the auditor
 Obtaining list of records, journals, and ledgers
 System of internal control and the extent of reliability
 General nature and operation of the business
 Consulting audit staff while preparing audit programmer
 Examining the system of bookkeeping, accounting system, etc.
CHAPTER FIVE

5. EVALUATION AND TESTING INTERNAL CONTROL

5.1. Basic Internal Control Concept
5.1.1. Meaning and significance of internal control
Internal control is broadly defined as a process designed to provide reasonable assurance

regarding the achievement of reliability of financial reporting, operational effectives and
efficiency, and compliance with applicable rules and regulations.
The generally accepted auditing standards required the auditor to obtain a sufficient understanding
of the client’s internal control. This helps the auditor to design effective procedures. The auditor’s
understanding of internal control also helps to assess control risk. Control risk is the possibility
that a material error or fraud will occur and not be prevented or detected by the client’s internal
control. In general, understanding internal controls is important to the overall audit activity and to
determine;
- The specific audit procedure to apply
- The extent of examination they should carry, and
- Timing of the procedures to be applied
5.1.2. Elements of Internal control
In every audit, the auditor must obtain understanding of the internal control structure in order to
develop adequate audit plan. This includes an understanding of the important elements of internal
control. These are,
Control environment: - the auditor should obtain sufficient knowledge of the control
environment to understand management’s and the BOD’s attitude, awareness and action
concerning the control environment. The control environment sets the tone of an organization,
influencing the control consciousness of its people.
Accounting system: - to understand the accounting system, the auditor must first understand
the major types of transactions preformed by the client. Next, the auditor should understand the
treatment of transactions including;
o how transactions are initiated
o the related accounting records used by clients and

o the manner of processing transaction

Risk Assessment
Having a clear set of objectives and establishing an effective control environment on assessment
of the risk facing the organization help to achieve its objective and missions which provides base
for developing an appropriate response to risk. Risk assessment is the process of identifying and
analyzing relevant risks to the achievement of the organ's objectives and determining appropriate
response.
Control Activities/procedure: - are those policies and procedures which are established to
achieve the organization's objective. Control activities is the major strategy for mitigating risk
control activity are the preventive or /and detective control measures taken. Corrective actions are
a necessary complement to IC activities in order to achieve objective. Control activities occurs
throughout the organ, at all levels and in all functions they include,
- Authorization and approval procedures
- Segregation of duties
- Control over access to records,
- Verification (transactions & significant events are verified before and after process
- Reconciling records which appropriate document
- Reviewing operating performance rate
Information and communication
Effective information & communication is vital for an organ to run and control its operation.
Inform & common related to organ's performance will create the possibility to evaluate the
orderliness, ethicality, economy, and efficiency and effectiveness of operations.
5.1.3. Basic principles of Governing Internal control
There are various methods and techniques of achieving a good internal control system. A good
internal control system will ordinarily include at least the following elements.
a. Competent, reliable staff with integrity

Competent members of staff techniques, professionally trained, an educated etc- is able to carry
out their duties more effectively and efficiently. Reliable members of staff with integrity are more
likely to carry out their duties more carefully and honestly.

If an organization meets these control criteria, it is probable the assets of the organization will be
secure (safe) and that its accounting records relatively free of material errors- hence reliable
records.
b. Clearly defined areas of Authority and Responsibility
These are need for authority and responsibility for each member of staff to be clearly spelt out.
This in turn helps the workers to known what is expected of them and also facilitates pinpointing
of responsibility where tasks have not been carried out according to specifications.
If this control element is net, it aids in contributing towards the achievement of smooth and
efficient operations (Co-ordination effect).
c. Proper Authorization procedures

This element calls for the establishment of procedures which ensure that all transactions are
initiated or approved by duly authorized personnel. This element can contribute towards achieving
observance of management policies as well as help in safe guarding the assets of an entity.
d. Adequate Documentation
It is important to maintain adequate records and documents. Such records should ensure
a. The organization’s documents are pre- numbered consecutively (Serialized) e.g. invoices,
payment vouchers. Official receipts, cheques, order forms etc.
b. Every transaction is supported by a source document
c. All accounting entries are supported by a source document/ duly authorized memo
d. Authorization is supported by written evidence
e. Adequate procedures manuals and job descriptions are availed to the members of staff.
If this Internal Control element is met by an organization, it is probable that:
i. if will secure reliable account date
ii. It will safe guard its assets
e. Segregation ( separation) of Incompatible Duties

Incompatible duties should be vested in different persons. Particularly
a. A Person who has custody of the assets (physical) should not be entering used with the
maintenance of records pertaining to these assets. E.g. a cashier should be allowed to
receive cash and cheques and make payments only. He/she should not be allowed to record
transactions relating to cash receipts and apartments. Why?

b. A person who has custody of the assets should not be allowed to authorize Transactions
relating to those assets. E.g. A store’s Manager should have no authority when it comes to
authorization of purchases and sales. Why?
c. No one person should have responsibility for all the entries in accounting records. It is
important for tasks to be work of another and in the process detecting unintended errors. If
this element of control present the assets of the entity will be safeguarded and also a
possibility of generating reliable data.
f. Physical safeguarding of the Assets
The most effective way of safeguarding the assets is to provide physical protection/ barriers to the
assets combined with restricted access to such assets.
E.g. I. Special designation of cash office for purpose of receiving and paying out cash. This also
includes designated persons for this purpose.
ii. Stocks and supplies should be in a locked store with access restricted to a limited number
of authorized persons.
iii. Cash, cheques and marketable securities should be kept in a safe with few personnel
having access to the safe key or combination lock.
Iv. Land and buildings may be protected by fences; locked gates (manned) CCT, Burglar
proof, smoke detectors etc.
v. Legal documents and accounting records should equally be protected by arranging for
facilities for safe keeping as well as limiting access to authorized personnel only.
vi. Motor vehicles / Tractors/ Motor bikes etc should be stored in locked garage and access
limited to authorized persons only.
g. Independent checks on performance

Unintended errors still occur even if an organization has competent workers and has clearly
defined areas of responsibility. This is due to human factors of tiredness, fatigue, boredom,
carelessness etc.
These are therefore needed to assign duties such that the work of one person automatically
crosschecks that of another employee.
E.g. I. one person should be in charge of debtors/ sales ledger while another person should be in
charge of debtors control account in the general ledger.

ii. Before a cheque is prepared, a different person should confirm among the invoice, order
form and receiving/ delivery note for reconciliation.
e.g. (a) Opening of the mail from the post office
(b) Combination key to the safe in the cash office.
iv. Generally, a further means of checking the performance of employees is for the
supervisors to review the work of subordinates regularly. Independent check on the performance
of workers can help an organization to:
(a) Achieve the generation of reliable accounting data: and
(b) Safeguard the assets of the entity
5.2. Evaluation of internal control
Thus involves two main steps

(i)Gathering information about the Internal control procedures
(ii) Evaluating their effectiveness in the prevention and detection of errors.
The primary means of gathering information about an organization’s Internal Control system is an
internal control questionnaire (ICQ). There are other means too of gathering this information.
a. Internal control questionnaire ( ICQ)

This consists of a set of questions posed by the auditor to be answered by the client. The questions
normally related to the control procedures that are considered necessary to detect/ prevent errors
occurring in each major type of transaction. These questions require short response of Yes /No or
no Applicable. Yes answers indicate the strength of an ICS while No or not Applicable answers.
Indicate weaknesses in the ICS
b. Use of system notes
This is a record of the ICS describing the operations of the entire Internal Control procedures
outlining where the ICS is weak and how serious the weaknesses are.
c. Use of third party confirmations

An auditor may use such a source to gain valuable and reliable information concerning the
strengths or other wise of an ICS.
E.g. confirmations with debtors, bankers, creditors, lawyers etc.

Any difference between third party evidence from the client’s own records is a sign of weak
internal control.
d. Use of compliance tests

These are tests aimed at analyzing the records and the recording system to ascertain whether they
are looking as prescribed comply with the laid down policies of the organization. If the results of
these tests indicate a strong ICS, the auditor will act accordingly and reduce the amount of
substantive testing.
e. Substantive tests
These are tests carried out to substantiate the accuracy and reliability of balances appearing in the
client’s records.
f. Observation
Thus techniques reveal deviations from normal, usual conduct of operations. It is used in areas
where there is no audit trail e.g. Cash count and stock takes. Any deviations from the laid down
polices is an indication of a weak ICS.
g. Walk through tests

These are limited in depth tests aimed at ascertaining the strength or otherwise of the accounting
system and hence the ICS.
Where the ICS is found to be weak, the auditor needs to:
I. Bring such weakness to the attention of management immediately and request that corrective
measures be taken. The auditor should include suggestions/ recommendations as to how the
corrective measures can be affected. The same weaknesses should be included in the management
letter to be issued at the end of the audit.
II. Change his audit approach in the areas where ICS is deemed to be weak from systems based
audit to vouching audit.
III. Increase substantive testing i.e. checking more balances to a boide any misstatements in those
statements.
IV. Increase the volume of testing to ensure that he gathers sufficient evidence.
V. Change the timing of the audit and in particular ensure that his audit plan affords him more
time to tackle key areas of the audit or areas with weak ICS.

VI. Record the weaknesses in his audit working papers so that in the near future he may
concentrate on such areas with weak ICs.
VII. If the weaknesses persist year after year; he should bring this to the attention of the share
holders so as to take an appropriate action.
VIII. If the ICS is too weak to allow testing, the auditor should qualify his audit report on the
strength of the fact that he is unable to obtain all the information and explanations necessary for
the purpose of his audit.
5.3. Relationship Between the independent Audit and Internal Audit
IA is an independent and objective assurance and consulting activity designed to add value and
improve an organizations operations. It helps an organization, accomplish its objectives by
bringing in a systematic and disciplined approach to evaluate the effectiveness of risk mgt, control
and governance process.
5.3.1. Point of Difference

Internal audit differs from external audit. The points of distinction are as under,
 An enterprise will go in use of internal audit only when it is convinced its utility interims of the
benefits offered and costs involved while, in case of enterprise which are under a statutory
obligation to have their accounts audited, appointment of internal auditor is must.
 The scope of internal audit is determined by mgt and be minimized or exchanged at any time.
While, the scope of external audit determined by the law applicable to enterprises under audit in
case of statutory obligations and under non statutory external audit, the scope is determined by
agreement between client and the auditor.
 Internal auditor is responsible primarily to mgt. while, the responsibility of external auditor is
primarily to the owners who have appointed him/her.
5.3.2. Cooperation’s
It is clear that internal audit work be developed in consultation with external auditors to avoid
unnecessary duplication of work.
External auditors should follow guidelines stared below,
 Internal audit reports are reviewed to determine tests to be undertaken.
 Internal audit manual be reviewed to ascertain the whole approach of work.
 Experience, qualification and relevance of internal audit staff are be carefully reviewed.

Mutual assistance between both would lead to reduction of the extent of details.
5.3.3. Quality of Internal Audit personnel
To achieve the goal of internal audit, properly equipped and professionally qualified internal
auditors must be produced
The following suggestions are offered to strengthen the internal audit work;
 Should be trained in human behavior
 Should be motivated to serve as watch dogs than blood hounds.
 Constrictive approach for problem solving should be indoctrinated
 Should be jeweled with modern concepts of audit.
 Special training should be imported for developing thoughts an efficient and economic use of
resources.
CHAPTER SIX
9. AUDIT REPORT
9.1. Basic Features of Audit Report
9.1.1. Introduction to Audit Report
Audit report prepared in accordance with standards of audit report. Standard of audit report is a
general guide line developed by AICPA (American Institution of Certified Public Accountant) in
1947. This standard includes four guidelines that must be followed in preparing audit report.
These are:
o The report should state whether financial statement stated in accordance with GAAP.
o The report should identify circumstance in which such principles have not been consistently
observed in the current period in relation to the preceding period.
o In formation disclosed in the financial statement is to be regarded as reasonably adequate unless

either wise stated in the report.
o The report should either contain an expression of opinion regarding the financial statement
taken as a whole, or an assertion to the effect that an opinion cannot be expressed.
The auditor report is the end product of an audit examination to communicate the users of
financial statements, and auditor’s inclusions regarding:

 Whether financial statement portray a true and fair view of the organizations financial position
and performance.
 Whether financial statement comply with relevant legislation. E.g. company law
The auditing profession recognizes the needs for uniformity in reporting to avoid confusion. Users
have considerable difficult in interpreting the meaning of an auditor’s report if each were an
original creation. The professional standards, therefore, have enumerated type of report that
should be included with financial statement. The wording of audit report reasonably uniform, but
different audit reports is appropriate for different circumstance.
In preparing audit report the auditor must consider the following important points:
 S/he has to objective in preparing audit report. It should have to be factual, unbiased and free
from distortion.
 The report must be clear. Clear report is easily understandable and logical. Therefore, avoiding
unnecessary technical language provide sufficient supportive information.
 Make the report concise and to the point.
The most type of audit report is the standard unqualified audit report. Auditors issue the standard
unqualified audit report when the following conditions have been met:
 All auditing standard have been followed in performing audit activity.
 Sufficient and appropriate evidence have been accumulated.
 All business organizations financial statement is presented in accordance with generally

accepted accounting principles.
 There are no circumstances requiring the addition of an explanatory paragraph or modification

of the report.
9.1.2. Content of Audit Report

The standard unqualified audit report includes the following contents.
Title: audit report should be addressed to the members of the company.
Address: the address of the company to whom the audit accomplished.

Introductory Paragraph: introductory paragraph contain in three important points.
Simple statement that the auditor performed an ‘audit’.
Lists the financial statement audited including balance sheet dates and accounting period for
income statement and statement of cash flow.
States that the financial statements are the responsibility of management and the auditor
responsibility is to express an opinion on the statements based on an audit finding.
Scope paragraph: is the factual statement about what the auditor did in the audit. This paragraph
states:
Whether the auditor followed GAAS.
Whether audit design to obtain reasonable assurance about the statements are free of material
misstatement.
Discuss the audit evidence accumulated and accumulated evidence is appropriate to express
opinion.
Opinion paragraph: include the auditor conclusions based on the results of examination.
Auditor signature: the signature may be signed by audit firm or by the individual auditor or by
both.
Date: the appropriate date for the report is the one on which the auditor has completed the most
audit procedure in the field. This date is important to users because it indicates the last day of
auditor’s responsibility for reviewing of significant events that occurred after the date of the
financial statement.
9.2. Types of audit Report
An auditor’s examination under GAAS may produce one of the four types of the opinion.
9.2.1. Unqualified Audit Opinion

An unqualified audit opinion communicates a favorable signal and means of the financial
statements present financial position, operational result, change in financial position in conformity
with GAAP. This type of report cannot be issued if any of GAAS is violated. However, when an
auditor emphasize in the report a particular matter of another auditor, when there is inconsistency
of accounting principle and methods but properly disclosed in the financial statements, and when
auditor’s have hesitation on the going concern of the business the middle paragraph like
introductory paragraph, scope and opinion paragraph may be changed and additional explanatory
paragraph can be added. Such opinion termed as unqualified opinion with explanatory paragraph.
But the additional paragraph does not change the meaning of unqualified opinion.
9.2.2. Qualified Audit Opinion
An auditor issues qualified audit opinion when there is significant limitation on the scope of the
audit or when financial statement is not in accordance with GAAP or when there is inconsistence
of GAAP but the overall financial statement are fairly presented.
Whenever auditor issues a qualified report, s/he use the term ‘except for’ in the opinion paragraph.
The implication is that the auditor is satisfied that the overall financial statement are fairly stated
‘except for’ a particular aspects expressed.
E.g. if accounting for inventory or accounting for cash or GAAP is not followed; and if the auditor
believes that this does not over shadow fairness of the financial statement s/he may issue qualified
audit opinion.
9.2.3. Adverse Audit Opinion
An adverse audit opinion is issued when the auditors believe that the overall financial statements
are so materially misstated or misleading that they do not present fairly the picture of the
organization. The auditor issues adverse opinion when s/he has gathered sufficient evidence and
conclude that the financial statement are materially misstated.
E.g., disagreement with accounting policy.
9.2.4. Disclaimer Audit Opinion
Disclaimer audit opinion issued when the auditor has been unable to satisfy himself/herself that
the overall financial statements are fairly presented. This type of opinion issued when there is

several limitations on the scope of the audit examination which prevents the auditor from
expressing an opinion on the financial statement as a whole.
Disclaimer audit opinion is different from adverse opinion because it is issued when there is no
sufficient evidence to conclude whether financial statements are fairly presented or not.
CHAPTER VII: AUDIT OF COOPERATIVE SOCIETIES
Introduction
6.1 Definition, objectives and Nature of Audit in Cooperatives
Cooperatives are basically socio-economic organizations to promote the economic interests
of their members with democratic management as its key principle. These cooperatives have
uneducated members especially at the primary level and the cooperatives are managed by ill
paid personnel / employees. Hence the handling of the business and money inherits certain
temptations by both the vested interests and employees. These conditions call for certain
precautions, which require many hard and fast rules with superior powers. To ensure the
proper use of funds and their accounts, there needs constant and vigilant scrutiny of the
accounts and examination of the general management. So examination of accounts or
auditing the accounts of cooperatives is considered essential.
Definition of Cooperative Audit
According to O.R.Krishnaswami, “Cooperative Audit is an examination of accounts and
an inquiry into the affairs of the society in order to ascertain the correctness of accounts and
the extent of which the activities of the society were useful in promoting the socio-economic
welfare of its members through the satisfaction of their needs in accordance with the
principles of cooperation”.
Objectives of cooperative audit
 To ascertain the correctness of accounts and records maintained by the cooperative
enterprise;
 To ascertain the actual financial conditions and earning of the cooperative society;
 To detect and prevent the occurrence of errors and frauds;
 To assess how far the cooperative society has been able to carry on business on sound
cooperative lines and secure economic benefit to its members; and
 To examine whether the affairs of the society have been carried on in accordance with the
principles of cooperation and the provisions of cooperative law.
Needs of Auditing for Cooperative organization
Need for Cooperative Audit
1. Protection of members: The representatives from among the members are expected to
carry on the administration of the society in accordance with the principles of

cooperation. For this purpose they have to institute a check system over them. Audit is
such check on the representatives in the interest of members.
2. Protection of creditors: Audit is needed to know the credit worthiness of cooperatives.
The creditors know the credit worthiness only through audit reports and financial
statements published by the cooperatives.
3. Protection of investors: Cooperatives accept deposits from the members and public. The
depositors attach much importance to audit of accounts of the cooperatives. Audit gives
them much confidence in the management of the societies and protects their interests by
making the actual state of the affairs of the cooperatives known.
4. Prevention of frauds: The accounts are maintained by the accountants and the affairs by
the managers of the cooperative society. Audit acts as a check on those responsible
persons, makes them to be regular and efficient in their work, and prevents the
occurrence of frauds and errors.
5. Successful management: The cooperatives are chiefly composed of uneducated
members. So the danger of their perversion to wrong ends is no means less and handling
of money involves certain temptations. These factors call for certain precautions.
Auditing is one of such precautions.
6. Maintenance of public image: Audit is necessary to maintain the public image. By
publicizing the financial statements and audit report through the media, the public image
of cooperatives can be maintained.
Difference between Cooperative audit and general Audit
The differences between cooperative audit and General Auditor audit of private enterprises are
given below:
Point of difference Cooperative Audit General / Private Audit
Statutory obligation Statutory audit but Statutory audit but
responsibility of taking up responsibility is of the board
audit is of the Registrar of of directors.
Cooperative Societies
Appointment of auditor By the Government By the shareholders
Act and Rules As per the Cooperative As per Company Law
Proclamation and bylaws,
and instructions by the
Registrar
Scope The scope is much as the The auditor has to report the
auditor has to examine the correctness of the profit and
overdue and verify & value loss, and the balance sheet.
the assets and liabilities.
Audit report Auditor has to submit report The auditor has to report to

to the Registrar through the the shareholders only

cooperative audit officer
Role of the auditor The auditor is required to be The shareholders and board
educative besides a critical members are mostly
to be the philosopher and businessmen and the auditor
guide as the members are is not expected to guide
not shrewd businessmen them.
Responsibility of the The auditor is expected to There is no such
auditor look after rules and bylaws responsibility of taking any
and if there are any action by the auditor.
financial losses due to
negligence, he has to report
specifically to the Registrar
for instituting proceedings
for assessing damages.
Audit fee Fixed by the Registrar Fixed by the general body
by specific contract.
Qualification of the Auditor Determined by the Registrar Auditor should be a Charted
Accountant
Power of the Auditor Cooperative auditor is given Auditor has no such power
power to summon the
person for producing the
records and receive
statements from employees
as well as members.
Nature or Aspects of cooperative audit

There are two aspects of cooperative audit viz., Statutory audit and State controlled audit.
Statutory Audit: When the audit of a cooperative is compulsory and statute, it is said to be a
statutory audit. The audit of a cooperative society is compulsory according to the Cooperative
Proclamation and it should be conducted at least once in a year. Thus the audit of a cooperative
society is annual legal obligations more over cooperatives are public concerns with public
importance.
State controlled audit: Cooperative movement in most of the developing countries is a
sponsored one. The government helps the cooperatives both financially and managerially. The
cooperatives registered under the Cooperative Proclamation are having the onerous task of
safeguarding the interests of the members and ensuring proper management. On this basis, the

Government from its Cooperative (Audit) Department appoints auditors to conduct audit in
cooperatives. The functioning and control of auditors are vested with the department and a copy
of audit should be submitted to the government.
6.2. Types of Cooperative Audit
Cooperative audit can be of four types. They are:
Interim Audit: Interim audit is a concurrent system of audit as applied to the audit of certain
types of cooperative societies such as rural / village credit societies. It is conducted in the interim
period between one final audit and the other. During this audit process the auditor checks the
financial transactions from the date of the previous final audit to the date of his visit and verifies
the ledger balances. A statement of receipts and payments for the period is prepared;
administrative check is done in great detail. It involves a detailed investigation into the affairs of
the cooperative. Verification of loans and examination of the items in the property statements of
members are carried out extensively. A detailed list of defects noticed is also prepared. The
auditor report is prepared in duplicate in the prescribed printed format. The original is given to
the society and the duplicate is submitted to the office of the district cooperative audit officer.
Interim audit minimizes the work of the final audit to a great extent with respect to mechanical
checking and administrative investigation. This audit process is done by the junior auditors.
Concurrent Audit: Concurrent audit is one which is done during the course of the period under
review. The auditor is engaged continuously through out the year or in the alternative, attending
to his work at frequent intervals or atleast once in a quarter during the period. It is not an audit
commenced after the end of the period. Hence it is termed as concurrent audit.
This kind of audit is followed and adopted in big cooperatives like central cooperative banks,
urban cooperative banks, wholesale consumer stores, sugar mills, spinning mills, etc., where the
work involved is considerable and where it would be disadvantageous to commence the audit
after the period.
Final Audit: Final audit is the statutory annual audit conducted in every registered cooperative
society every cooperative year. It is a complete audit for the year leading to closing the accounts
for the particular year and the preparation of receipts and payments statements, profit and loss
account, and the balance sheet. The work involved in the final audit consists of a mechanical
check and administrative examination of books of accounts, registers, etc., from the date up to
which the interim or concurrent audit has been completed till the last date of the cooperative
year. It also includes verification of cash balance and securities, verification and valuation of
assets and liabilities, and examination of overdue debts, if any, with special reference to the
statutory obligation under the cooperative proclamation. A thorough investigation into the affairs
of the society should be made in order to gauge the benefit rendered by the society to its
members.
The final audit report is prepared in a prescribed format. The format varies according to the type
of cooperative. One copy of the audit report is submitted to the district cooperative audit officer

with the various schedules prepared by the auditor. The auditor should also furnish a certificate
of audit in the prescribed format.
Test Audit: Test audit is an audit conducted in order to test the correctness of the final audit done
by the auditor. It is a re-audit process of the accounts of a certain number of societies which an
auditor has audited. Test audit is not an examination of accounts at random; it is a full re-audit of
all accounts of a cooperative society. But all societies are not test audited during a year; only a
certain percentage of societies are test audited. The objectives of test audit are as follows:
 To check the efficiency of audit staff;
 To find out the mistakes committed by the audit staff so as to guide them to do with work
property; and
 To ensure correct and efficient audit of societies.
6.3. Right, duties and powers of Cooperative Auditors

Cooperative Auditors’ Rights and Duties
The auditor has various detailed duties to perform in order to achieve the overall duty to report
on the true and fair view. In order to fulfill these duties, various legal rights are given to the
auditor.
Duties of the auditor:
The duties of the auditor under national legislation generally fall under the following headings:
 To report to the shareholders or directors on whether financial statements of the company
show a true and fair view or present fairly and have been properly prepared in accordance
with legislation
 To consider whether the information in the Management report is consistent with the
financial statement
 To give various details required by legislation in his report, if not given in the financial
statements themselves.
 To form an opinion as to whether:
o Proper accounting records have been kept by the company
o The profit for the year and balance sheet totals are fairly stated

o Such information and explanations as the auditor thinks necessary for the
performance of his duties have been received from the company’s officers
 To report on any violation of law or the company’s constitution
 To ma a statement of circumstances when he ceases to hold the office of auditor for any
reason.
Rights of the auditor
The rights given to the auditor under national legislation are designed to ensure that he is able to
fulfill his duties and responsibilities to the members. These rights are fundamental to his
independence. In countries with a well-developed auditing profession, auditors generally have
unrestricted rights of access to books and records of a company, subject only perhaps, to
considerations of national security. In those countries where there is no tradition of reporting in
true and fair terms, it often comes as a surprise to directors and employees to find auditors asking
for documents that previously, only the tax auditors had a right to see. The list of rights set out
below reflects the position in countries in which the profession is mature.
Legal rights:
 The rights of access t the books, records, documents and accounts of the company
 The right to require from the officers of the company such information and explanations
as he thinks necessary for the performance of his duties.
 The rights to:
o Receive all notices relating to any general meetings of the company
o Attend any general meetings, and
o Be heard at any general meeting on any part of the business, which concerns his
as auditor.
 The right to be sent by the company a copy of a notice of intention to propose his
removal or replacement and the right to make written or oral representations
 The right to require the directors to requisition a general meeting on his resignation and
to attend and be heard at that and any other meeting that concerns him.


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Cooperative Auditing I, for 3rd year cooperative students

1.1. Definition of Auditing

The American Accounting Association, committee on Basic Auditing concepts - Defined

Auditing is systematic process of objectively obtaining and evaluating evidence regarding

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1.2. Historical Development of Auditing

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The objectives of an audit may broadly be categorized as:

1. Primary objective: Expression of independent opinion on accounts

i) Cost audit (verification of cost records and examination of cost accounting

ii) Management audit (checking managerial functions and verification of

By Telila E, 2014GC Page 3

1.3. Importance of Auditing

Some of the importances of auditing are given below.

1.4. Scope of Audit

The scope of an audit is dependent upon:

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1.5. Accounting vs. Auditing

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c. Financial statement Audit: - is conducted to determine whether the overall financial

Environmental audit for industrial or commercial establishment refers to checking of the

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Enable assessment of money value of social contributions of an enterprise, specially designed

It is a complete audit for the year

The auditors attend to his work at frequent intervals

Based on legal basis of audit

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Generally Accepted Auditing Standards (GAAS)

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1.2.4. Comparison of financial statement audit with non financial audit

 Performance and Financial Statement Audit

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 Comparison of Financial statement audit and other Types of audit

Similarity of Financial statement audit and other types of audit

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auditor determined by the

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3. PROFESSIONAL ETHICS AND LIABILITEIS OF AUDITOR

3.1.1. Meaning of professional ethics

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1. Professional competence and technical standard

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3.2. Auditors professional Responsibility and liability

3.2.1. Auditors Professional Responsibility

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3.2.3. Auditors Liability

1. Auditors’ liability to third party

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2. Auditors’ liability to the public

Liability for professional negligence

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Audit Evidence and Its Documentation

2.1.1. Meaning, Source and Types of Audit Evidence

Source and types of audit evidence

Classification of Audit Evidence

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Audit evidence may be classified on the following basis:

2.1.2. Attributes of Audit evidence