External Audit and Financial Statements - Essay Example

Task MEMORANDUM Mr. Gill Accountant, Smith Jones & Co., Sub: Roles and Responsibilities of External Auditors in a Sta y Audit An external auditor is appointed independent of the body being audited. An external auditor'sprimary concern is whether the financial statements are free of material misstatements. On the other hand, an internal auditor's role is determined by management and the directors and their objectives differ from that of the external auditor's. Nevertheless some of the means of achieving their respective objectives are often similar and thus certain of the work of internal auditor may be useful in determining the nature, timing and extent of external audit procedures. Therefore, their roles and objectives are different but complementary. The scope of external auditor's work covers the audit of financial statements, probity in the use of public money and value for money in the use of resources. Internal auditor objectively examines, evaluates and reports on the adequacy of the internal control environment as a contribution to the proper, economic, efficient and effective use of resources. External audit is conducted in accordance with International Standards on Auditing (ISA) and with the Audit Commission's Code of Audit Practice. Internal audit's strategy and plan is agreed between internal audit and management. It is approved by the Audit Committee and cannot be directed by external auditor. Effective co-operation between external auditor and internal auditor means more than avoiding duplication. An effective framework of co-operation and co-ordination ensures liaison, co-operation on work programmes and the sharing of information. This can be achieved through: (a) Regular Liaison meetings between external auditor and internal auditor (b) External audit reliance on the internal audit work (c) Arrangements for sharing documents and information (d) Arrangements for pre-Audit Committee liaison (e) External audit's review of internal audit work. The external auditor has various responsibilities when it comes to performing the audit. It is the responsibility of the external auditors to perform audit of financial statements in such a way that they areable to form opinion, including: (a) Whether the financial statements present fairly, or give a true and fair view of, the financial position of the audited body and its expenditure and income for the year in question (b) Whether they have been prepared properly in accordance with relevant legislation, applicable accounting standards and other statutory requirements (c) Whether they are free from material misstatements Auditors have a responsibility to satisfy themselves that the audited body has put in place proper arrangements to secure economy, efficiency and effectiveness in its use of resources. While doing so, the auditor must consider and assess the relevant significant business risks. Auditors are not required to report to audited bodies on the accuracy of performance information that the audited bodies publish. Auditor's work is limited to review of the systemsput in place by the audited body to collect, record and publish the information. Nor are auditors required to form a view on the realism and achievability of the assessments published by those audited bodies. The auditor's report should contain a clear written expression of opinion on the financial statements taken as a whole. The auditor's report includes the following basic elements: (a) Title (b) Addressee (c) Opening or introductory paragraph containing (i) Identification of the financial statements audited (ii) A statement of the responsibility of the entity management and the responsibility of the auditor (d) Scope paragraph containing (i) A reference to ISAs or relevant national standards or practices (ii) A description of work performed by auditor (e) Opinion paragraph containing (i) A reference to the financial reporting framework used to prepare the financial statements (ii) An expression of opinion on the financial statements (f) Date of the report (g) Auditor's address (h) Auditor's signature An unqualified opinion should be expressed by an auditor only when the auditor is able to conclude that the financial statements give a true and fair view in accordance with the identified financial reporting framework. However, the following two circumstances could lead to a qualified opinion: (a) There is a limitation on the scope of the auditor's work or (b) There is a disagreement with management regarding the acceptability of the accounting policies selected, the method of their application or the adequacy of financial statement disclosures. For instance, if the auditor is not able to gain access to certain set of books, this would lead to a limitation on the scope of auditor's work and hence would give rise to a qualified opinion. Written representations from management required as audit evidence are obtained before the audit report is issued. However, a management letter is ordinarily dated the same date as the auditor's report. It is always addressed to the auditor. In addition it would contain date of letter, explanations provided by management and signatures of members of management who have primary responsibility for the entity and its financial aspects. We sincerely wish that taking into consideration the abovementioned information regarding the roles and responsibilities of an auditor, you would reconsider your plans of taking legal action. (http://www.hertsdirect.org/yrccouncil/civic_calendar/archive/Audit%20Committee_9/Item%204a%20%20Protocol%20for%20liaison%20between%20Internal%20and%20External%20Audit%20-%20Hertfordshire%20CC%20v1.0.pdf) (http://www.audit-commission.gov.uk/reports/accessible.aspProdID=A9F9AD95-AE7D-4755-935B-94700E020A9E) (http://www.frc.org.uk/images/uploaded/documents/ACFAB4.pdf) (http://www.cpaireland.ie/UserFiles/File/Technical%20Resources/Auditing/International%20Standards%20on%20Auditing/ISA%20580.pdf) Task 2:- The suitable approach to the audit of the Navy Bookshop Ltd. would be Risk Based Audit. In the Substantive test approach, audit resources are targeted on testing large volumes of transactions and account balances without any particular focus on specified areas of the financial statements. The System Based approach requires auditors to assess the effectiveness of the internal control of the entity, and then to direct substantive procedures to those areas where it is considered that systems objectives will not be met. In the Risk Based approach, audit resources are directed towards those areas of the financial statements that may contain misstatements in the form of error or omission as a consequence of the risk faced by the entity. An effective risk based audit program will cover all the major activities of an entity. However, the frequency and depth of each area's audit will vary according to the risk assessment of that area. Also, auditors/examiners should determine whether the audit function is appropriate for the size and complexity of the institution. For most entities, the risk based approach minimises the possibility of audit objectives not being met. Consequently, ISA 315 "Identifying and Assessing the Risks of Material Misstatements through Understanding the Entity and its Environment" (Redrafted) compels auditors to adopt a risk based approach. (http://www.accaglobal.com/pubs/students/publications/student_accountant/archive/sa_feb08_pine.pdf) Task 3:- It would be advisable to record the audit work carried out on The Navy Bookshop Ltd. in the Audit file and working papers. An internal control questionnaire would only provide a series of yes or no answers to questions regarding the entity's structure and internal control. Even a flowchart would only be used to document how the entity's system works. Audit working papers would be preferred over internal control questionnaire and flowchart due to its importance as stated in ISA 230 "Audit Documentation" (Revised). Working papers are not only necessary for audit quality control purposes, but also provide evidence that the audit has been conducted effectively and assurance that the work delegated by the audit partner has been properly completed. Working papers also function as a record of matters of continuing significance for future audits. (http://www.accaglobal.com/pubs/students/publications/student_accountant/archive/sa_feb07_F8P7.pdf) Task 4:- (1) Audit of freehold garage sold: (a) Ensure the sale is properly authorised. (b) Ensure the sale proceeds are received and properly recorded. (c) Ensure profit or loss on sale of the garage is properly recorded. (2) Audit of new computer purchased: (a) Vouch invoice and agree description, price, date of purchase etc. (b) To ensure ownership, vouch delivery order. (c) Ensure appropriate authority for acquisition. (d)Check physical existence of the computer. (e) Ensure the same has been properly accounted for. (3) Audit of premises taken on lease:- (a) Review lease agreement to ensure parties involved and understand the lease terms. (b) Ensure lease arrangement is properly approved. (c) Check if the rent is being paid on a regular basis. (4) Audit of debtor's balance outstanding for four months:- (a) Verify if it is a common trend to have balances outstanding for such long periods (b) Enquire if the debtor is a related party (c) Obtain confirmation from the debtor (5) Audit of new delivery van purchased: (a) Vouch invoice and agree description, price, date of purchase etc. (b) To ensure ownership, vouch delivery van registration card. (c) Ensure appropriate authorization for acquisition was obtained. (d)Check physical existence of the van. (e) Ensure the same has been properly accounted for. Task 5:- Some of the major risks while auditing a small business such as The Navy Bookshop Ltd. are: (a) Risk of collusion among employees (b) Risks connected to related party transactions (c) Risk of cash embezzlement (d) Risk of non-availability of appropriate information (e) High likelihood of ignoring internal controls (f) High likelihood of internal control not being effective (6) Since there are only ten members receiving salary, there would be lesser number of transactions relating to salary paid. Therefore, 100% examination can be conducted. This would also be necessary since the seven casual workers are paid in cash. Therefore, it would not be necessary to use statistical sampling. However, through the test of controls, if it is found that an effective internal control system is in place, statistical sampling may be used. The procedure to be followed is as follows: (a) Verify through 100% examination if the salary in cash is actually paid and properly accounted for. (b) Vouch the payments with salary statements (c) Ensure statutory as well as voluntary deductions are made (d) Ensure no fictitious payments are made With regard to the debtors' accounts, statistical sampling based on amount of transaction can be used. Transactions involving amounts higher than a certain amount can be considered. The procedure to be used is as follows: (a) Vouch invoices raised on random selection basis (b) Check if supporting information is retained for the invoices raised (c) Check using statistical sampling if payments are recorded correctly (d) Review effectiveness of recovery action (e) Review level of outstanding debts Bibliography Hertfordshire County Council. Protocol for liaison between Internal and External Audit. Available at: http://www.hertsdirect.org/yrccouncil/civic_calendar/archive/Audit%20Committee_9/Item%204a%20%20Protocol%20for%20liaison%20between%20Internal%20and%20External%20Audit%20-%20Hertfordshire%20CC%20v1.0.pdf (Accessed 22 April 2009) The Audit Commission. 2005. Statement of responsibilities of auditors and of audited bodies. Available at: http://www.audit-commission.gov.uk/reports/accessible.aspProdID=A9F9AD95-AE7D-4755-935B-94700E020A9E (Accessed 22 April 2009) International Standard on Auditing (UK and Ireland) 700 - The Auditor's Report on Financial Statements. Available at: http://www.frc.org.uk/images/uploaded/documents/ACFAB4.pdf (Accessed 22 April 2009) International Standard on Auditing (UK and Ireland) 580 - Management Representations. Available at: http://www.cpaireland.ie/UserFiles/File/Technical%20Resources/Auditing/International%20Standards%20on%20Auditing/ISA%20580.pdf (Accessed 22 April 2009) A risk-based approach to auditing financial statements. Available at: http://www.accaglobal.com/pubs/students/publications/student_accountant/archive/sa_feb08_pine.pdf (Accessed 22 April 2009) Audit Working Papers. Available at: http://www.accaglobal.com/pubs/students/publications/student_accountant/archive/sa_feb07_F8P7.pdf (Accessed 22 April 2009) Read More