ISL458U-AUDITING
Chapter 3: Overview of the Auditing Process
Introduction
The primary responsibility of the auditors is to form and express an audit opinion on whether their client firm’s financial statements, fairly, present the client firm’s financial position and performance and whether their financial statements are properly prepared in accordance with the applicable financial reporting framework and legal requirements. In order to form an audit opinion, auditors must obtain evidence and evaluate sufficient appropriate audit evidence which is collected through the audit process.
Principles of Audit Process
Principles of audit process consist of the components of the audit process. There are eleven components of the principles of the audit process: procedures of quality control, objectives of the auditor, professional judgment, professional skepticism, financial statement cycles, management assertions, audit objectives, audit evidence, audit procedures, audit techniques, audit sampling, and audit documentation.
Procedures of Quality Control
According to the International Standard on Quality Control, the audit firm must establish and maintain a system of quality control.
Leadership Responsibilities For Quality
When top management of the audit firm establishes policies and procedures designed to promote an internal culture recognizing that quality is essential in performing audit engagements, this internal culture will be adopted by the audit firm’s staff so that they perform audit work in compliance with auditing standards and legal requirements and issue reports that are in line with their obtained sufficient appropriate audit evidence.
Relevant Ethical Requirements
In an audit firm, the policies and procedures of quality control must be designed to prepare the audit firm and its staff to comply with the following relevant ethical requirements: Integrity, Objectivity, Professional competence and due care, Confidentiality, Professional behavior, Independence of mind, and Independence in appearance.
Acceptance and Continuance of Client Relationship and Audit Engagement
The audit firm’s management should answer the following example questions for acceptance or continuance of the client relationship:
• Is the audit firm competent to perform the audit engagement? • Does the audit firm have the capabilities of the audit engagement, including time and resources? • Can the audit firm comply with relevant ethical requirements?
• Has the audit firm considered the integrity of the client firm?
Human Resources
Audit firm must establish policies and procedures designed to provide that it has sufficient staff with the competence, capabilities and commitment to ethical principles to plan and perform the audit in accordance with auditing standards and applicable legal and regulatory requirements.
• All new personnel should be qualified to perform their work competently (recruitment). • Work is assigned to staff who have adequate technical training and proficiency (competence). • All staff should participate in continuing professional education and professional development activities (competence). • Staff selected for promotion have the qualifications necessary for the fulfillment of their assigned responsibilities (promotion). • Each auditor must be evaluated on every audit engagement using the audit firm’s individual engagement evaluation report (performance evaluation).
Engagement Performance
An audit firm must establish policies and procedures designed to provide that audit engagements are performed in accordance with auditing standards and applicable legal and regulatory requirements and enable the audit firm to issue audit reports that have appropriate audit opinion. Such policies include consistency in the quality of engagement performance, supervision responsibilities and review responsibilities.
Monitoring
An audit firm must establish a monitoring process designed to provide that the policies and procedures related to the system of quality control are relevant, adequate, and operating effectively. Examples of the monitoring process include ongoing evaluation of the audit firm’s system of internal control, annual testing of quality control procedures and periodic inspection of at least one completed engagement.
Documentation of System of Quality Control
The form or content of the documentation depends on the audit firm’s size, nature, complexity of its practices and organization.
Objectives of the Auditor
As a measure of the level of certainty that the auditor has obtained at the completion of the audit, assurance must be reasonable rather than absolute because the auditor is not an insurer or guarantor of the 100% correctness of the financial statements. Therefore, an auditor that conducts an audit in accordance with auditing standards may fail to detect material misstatements. When financial statements
are materially misstated, the probability of expressing an inappropriate audit opinion usually exists. This is called audit risk. Audit risk is a function of the risks of material misstatement and detection risk. In other words, there are two main components of audit risk: risk of material misstatements and detection risk.
Risk of material misstatement is the risk that financial statements are materially misstated prior to audit. It is generated from the client firm. The auditor has no effect on it. It has two components: inherent risk and control risk. Inherent risk measures the auditor’s assessment of the risk or likelihood of material misstatement being present about a class of transaction, account balance, or disclosure, before considering the effectiveness of related internal controls. This risk is generated from three main sources:
• Management integrity • Account risk • Business risk
Control risk is the risk that a material misstatement could occur in the client firm’s accounting data about a class of transaction, account balance, or disclosure that will not be prevented, or detected and corrected, on a timely basis by the client firm’s internal control.
Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level, will not detect a misstatement that exists and that could be material. This risk is under the direct control of the auditor. Detection risk has two components: sampling risk and non-sampling risk. Sampling risk is the risk or the likelihood that the auditor fails to detect material misstatements about a class of transactions, account balances and disclosures because the entire population was not examined. In other words, examination is limited to audit samples. On the other hand, non-sampling risk is the risk or likelihood that the auditor will fail to detect material misstatements because sufficient appropriate audit evidence is not collected and/or is not evaluated properly because it should be noted that audit staff may not make optimal judgments to select the appropriate audit procedures and to reach appropriate conclusion throughout an audit.
Professional Skepticism and Professional Judgment
Professional judgment is the application of relevant training, knowledge and experience, within the context provided by auditing, accounting and auditing standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement. Unlike the professional judgment, professional skepticism is an attitude questioning in mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.
Overview of the Relationship of Financial Statement Assertions to the Audit
In conducting an audit, it should be noted that there is a strong relationship among the financial statements, management assertions about components of the financial statements, audit objectives, audit procedures, audit evidence and the audit report.
Stages of Audit Process
Initial Stage “Risk Assessment” Audit Planning Process
The audit planning process consists of eight sub-stages:
• Accept client and perform initial audit planning, • Understand the client’s business and industry • Perform preliminary analytical procedures • Set preliminary judgment of materiality and performance materiality • Identify signicant risks due to fraud or error Assess inherent risk • Understand internal control and assess control risk • Finalize overall audit strategy and audit plan.
2nd Stage “Risk Response”
This stage includes the following substages:
• Perform Test of Controls, • Substantive Tests of Transactions, • Substantive Analytical Procedures • Tests of Details of Balances
Final Stage “Reporting”
This stage means completing the audit and issue an audit report, and it consists of the following substages:
• Perform additional tests for presentation and disclosure • Accumulate final evidence • Evaluate results • Issue audit report