Auditing Part 3
Auditing Part 3
Auditing Part 3
At this point, you are going to work on one particular transaction cycle (only) depending upon
what was assigned to your team (Make sure you are updated with the advisory as to what
transaction cycle will be audited by team in which you are a member)
1. Assess inherent risk qualitatively at assertion level (on the transaction cycle). After
which quantify such assessment.
Receivables incorrectly classified as current when likelihood of collection during
next year is low
Collection of a receivable contingent on specific events that cannot currently be
estimated Payment not required until purchaser sells product to its end customers
Accounts receivable aged incorrectly, and potentially uncollectible amounts not
recognized Orders accepted from customers with poor credit, but allowance for
doubtful accounts not increased accordingly
Right of customer to return a product, as well as returns history
Proper treatment of sales transactions made with recourse or that have an abnormal
or unpredictable amount of returns.
In this, the Inherent Risk of the company is more or less 80% when it comes to the
Revenue & Collection Cycle of the company.
2. Preliminarily obtain understanding of the client's internal control by following the steps
below:
a. Base on the information you gathered in Activity 2, prepare a flowchart
supported by explanation on critical areas to document your understanding about
the client's internal control.
The Revenue cycle flow chart consist the process in the important areas of the cycle
to document the client's internal control. The steps and its important detailed process are
the following:
1. Production Department inform the Sales Department of the finished goods/orders.
Wholesale or outlet supervisor coordinate with the customer and approved
dispatching of goods for delivery. Dispatch order is
accomplished in triplicate; 1) original - file copy 2) duplicate to AR clerk & 3) triplicate
to Stockroom.
2. Quadruplicate copy of sales invoice is prepared by the AR clerk upon the receipt of
dispatch order from the Sales Dept. Entries in the invoice is based on the dispatch
order. Except for the quadruplicate copy, all copies of the invoice are forwarded to
stockroom to be included in delivery of goods. Remaining copy is used as basis in
recording in the sales journal.
3. Duplicate & Triplicate copies were returned with customer acknowledgement
receipt. Duplicate copy is
forwarded to AR clerk while the triplicate copy is retained by the stockroom.
4. AR clerk send collection letter five days after the date of delivery. Part of the job of
AR clerk is to go to customers and collect amount due 15 days after delivery or until
the account is fully paid.
The critical areas of the process are the recording of the sales and collection of
accounts receivable that needs more inspection and monitoring of the staff.
b. After which you are ask to prepare a tabulation of error or fraud that may
occurred with the present system of internal control.
AR clerk visit the outlets Receiving remittances must be Without proper schedule or
once or twice a week done on a scheduled and regular cutoff of remitting it can be
received remittances. basis. done in an improper way and
unrecorded if the situation
permits the AR clerk.
c. With your tabulation above evaluate the effectiveness of the internal control covering
the transaction cycle that was assigned to you and give your preliminary assessment
of control risk (maximum, high, moderate or low). Explain your answer
d. With these possible errors or fraud, you are asking to prepare a recommendation on
how internal control system can be improved (total revision of the system is not
allowed).
The auditor can recommend to the organization that there should always be a
separation of duties in all aspects of transactions and make sure that there are double
checking personnel who will confirm the computed collections and any other areas
related. Make sure that the recorded accounts and amounts are up to date or on its real
time transaction to mitigate the errors that may happen. Being careful and hands-on
on the flow of transaction will greatly help the organization to its success and fair
view presentation of financial statements.
IMPORTANT ASSUMPTION (only for those who assessed Control Risk at Maximum):
If your assessment of control risk is at maximum, your activity ends here. Thus, an
important assumption is added to you - Assuming that the In-charge Audit Partner lowered
the assessment to below maximum since the effect of internal control weaknesses can be
addressed by the team's audit strategy making it appropriate to conduct test of controls.
Therefore, irrespective of your actual findings you will assume that control risk is below
maximum in the succeeding activities. For this purpose, you have to quantify Control Risk
assessment to a percentage of what could have been made by your In-charge Audit Partner
and use it in the following requirements.
3. Mathematically show the relationship between audit risk and its components by
a. Using the risk model and considering the assessment of audit, inherent and
control risks determine allowable detection risk
b. Explain how the result of computation above will affect the nature, time & extend
of audit procedures required by the engagement in general.
The audit risk model has become increasingly important. Regulations for
business accountability became more strict and other legislation designed to beef
up auditing practices and provide more information to investors. The audit risk
model, with its flexibility and broad-based approach, allows auditors to
incorporate such standards and make strong audits that both businesses and
investors can count on.
The audit risk model is a vital step for complex audits because it allows
for a great amount of adaptation. If auditors were limited to a set audit procedure
composed of steps they had to follow, they would not be able to change their
approach based on the company and audits would not be complete or useful. The
risk model allows for assessment of the current situation and makes the resulting
audit a flexible tool that can be used to inspect for particular errors
PHASE 2 - RISK RESPONSE (TEST OF CONTROLS)
Activity 5 - Determine overall response of the auditor related to the risk assessed at
Financial Statement level & Assertion Level, explain how it will affect the following:
1. Professional skepticism
Financial Statement Level- the auditor should evaluate the integrity of the management,
assess the management experiences and knowledge and the changes of management during
the period to know if the management is inexperience that could possibly affect the
preparation of the financial statements of the company and to determine if there are unusual
pressure on the management to misstate the F/S possibly due to the industry experiencing
large number of business failures or if the going concern assumption is in question. For the
auditor to detect on who will possibly commit fraud or error.
Assertion Level- the auditor to determine the financial accounts that are susceptible to
misstatements and to determine the complexity of transactions and other events that may
require the work of an expert. For the auditor to ascertain on which accounts are prone to
misstatements so that the auditor would focus to those critical transactions that could affect
the financial statements.
Assertion Level- Every staffed assigned should be knowledgeable about the process, scope
and handling of the case assigned. The knowledge, skill, and ability of personnel assigned is
significant.
Assertion Level- the auditor should evaluate if the accounts are properly recognized in the
books of the company using the accounting policies set by the PFRS or PAS and determine
which accounts are recorded erroneously or due to fraud committed by the management.
Assertion Level-since unpredictable tests are required in the audit, concealment of fraud will
be mitigated. Those accounts that are susceptible for fraud or error should undergo in the
unpredictable tests by the auditor.
Upon the development information that gives rise to additional perceived areas prone to
material misstatements, audit procedures will be further applied for the aim of attaining
dealing with those assessed risks. Number of procedures to be done is carefully taken into
consideration, wherein evidence that will further reduce risk of misstatement to that assertion
is also considered. Generally, the selection of particular procedures which is aimed at
objective attainment is influenced by several considerations such as the nature and
materiality of the particular component of the financial statements, nature of the audit
objective to be achieved, reliance that can be placed on internal control structure, relative risk
of material errors or irregularities, kinds and competence of available evidence and the
expected efficiency and effectiveness of possible audit procedures
1. Based on the computation of Allowed Detection Risk in Activity 4.3.a & the Audit Plan in
Activity 2, prepare Initial Substantive Audit Program by accomplishing the table below:
Assertion Audit Objective Substantive Audit Procedure
2. Explain how these audit procedures provide assurance that the Allowable Detection Risk will
be achieved.
The Allowable Detection Risk will be achieved if the auditor will carefully follow the
audit procedures mentioned above. The auditor set the allowable detection risk to assess how
many percent of not detecting an error or fraud will likely to occur in the audit work being
performed. It is important that auditor should pay attention as to the technical aspects of the
audit to ascertain that the auditor will detect possible errors and fraud at financial statements
level and at assertion level.
Keep in mind that you can never completely eliminate detection risk because you’ll most
likely never look at each and every transaction. You’ll always have some risk of a
misstatement being missed, but your goal is to keep it to an acceptable minimum. The only
way to eliminate detection risk completely is to examine every transaction. Because
reviewing every item isn’t practical, auditors use sampling methods to assess transactions
and balances. Therefore, the auditor aims to keep the detection risk within an acceptable
level.
1. Based on the preliminary assessment of control risk in Activity 4.2.d. and in consideration of
the Initial Substantive Audit Program you accomplish above, prepare Audit Program for Test
of Control by: