Audit Manual – Table of Contents
i
Table of Contents
1. ORGANISATION AND PURPOSE OF THE MANUAL
1.1 Purpose of the Audit manual 1-1
1.2 Types of audits dealt with 1-1
1.3 Audit entities dealt with 1-2
1.4 Accounting Responsibility Structure of the Government of Pakistan 1-2
1.5 Stages of audit work dealt with 1-3
1.6 Organisation of the manual 1-3
1.7 Links to other guidance material 1-3
1.8 Standard audit working paper kit 1-4
1.9 Need for professional judgment 1-4
1.0 Updating the Audit Manual 1-4
2. ROLE OF THE AUDITOR GENERAL
2.1 Parliamentary Control and Public Accountability 2-1
2.2 Introduction to Auditing 2-1
2.3 Legislative Basis 2-1
2.4 Vision, Mission and Values 2-3
3. THE JOB OF THE AUDITOR
3.1 Introduction 3-1
3.2 Expectations 3-1
3.3 Conditions of Employment 3-1
3.4 Code of Ethics 3-1
3.5 Glossary 3-5
3.1 Protection of the Auditor 3-5
4. DAGP AUDIT STANDARDS
4.1 Basic Principles in Government Auditing 4-1
4.2 General Standards in Government Auditing 4-7
4.3 Standards with Ethical Significance 4-11
4.4 Field Standards in Government Auditing 4-16
4.5 Reporting Standards in Government Auditing 4-24
5. DAGP’S ANNUAL PLANNING PROCESS
5.1 DAGP Strategic Audit Objectives 5-1
5.2 DAGP Audit Scope 5-1
5.3 DAGP Strategic Audit Plans 5-2
5.4 The annual planning process 5-2
5.5 Integration of audit work 5-4
5.6 Approval process for the budget of centrally-led audits 5-5
6. THE AUDIT CYCLE
6.1 Introduction 6-1
6.2 General Audit Planning 6-4
6.3 Activity and Resource Planning 6-9
6.4 Roles and Responsibilities 6-11
7. PLANNING THE AUDIT
7.1 Step1 – Establish Audit Objectives and Scope 7-1
7.2 Step 2 –Understand the Entity’s Business 7-4
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Audit Manual – Table of Contents
7.3 Step 3 – Assess Materiality, Planned Precision, and Audit Risk 7-7
7.4 Step 4 – Understand the Entity’s Internal Control Structure 7-19
7.5 Step 5 – Determine Components 7-27
7.6 Step 6 – Determine Financial Audit and Compliance with Authority Objectives, and
Error/Irregularity Conditions 7-35
7.7 Step 7 - Assess Inherent Risk and Control Risk 7-41
7.8 Step 8 – Determine Mix of Tests of Internal Controls, Analytical Procedures and
Substantive Tests of Details 7-41
7.9 Reliance on Other Auditors 7-49
7.10 Documenting Strategic Planning Decisions 7-51
7.11 Application to Government-Wide Audits 7-51
8. ACTIVITY AND RESOURCE PLANNING FOR INDIVIDUAL AUDITS
8.1 Introduction 8-1
8.2 Formulate/Update Audit Programmes 8-1
8.3 Updating Staffing Requirements and Allocating Resources 8-3
8.4 Updating Budget Requirements 8-4
8.5 Updating Timing Considerations 8-7
8.6 Factors to consider when determining the optimum timing 8-8
8.7 Updating Information Required From the Entity 8-8
8.8 Re-Assessing the General and Detailed Planning Decisions for Individual Audit 8-9
8.9 Documenting the Detailed Planning Decision 8-9
8.9 Updated Planning File 8-10
8.10 Approval of the General and Detailed Planning Decisions 8-11
9. CONDUCTING THE AUDIT
9.1 Introduction 9-1
9.2 Compliance Testing 9-1
9.3 Substantive Testing 9-2
9.4 Evidence 9-6
9.5 Matters to Deal with During Fieldwork 9-13
9.6 Cause and Effect Analysis 9-16
9.7 Developing Conclusions and Recommendations 9-17
9.8 Keeping Entity Official Informed 9-19
9.9 Documenting the Work Performed 9-20
9.10 Custody and Maintenance of Working Paper Files 9-23
9.11 Quality Assurance during Field Work 9-23
10. EVALUATING AUDIT RESULTS
10.1 Evaluating Financial Audit Results 10-1
10.2 Known Errors, Most Likely Errors, Further Possible Errors and Maximum Possible
Errors 10-2
10.3 Determining the Cause of Errors, Violations and Deviations 10-5
10.4 Concluding on the On the Results of Each Test 10-6
10.5 Concluding on the Results of Each Component 10-9
10.6 Concluding on the Financial Statements as a Whole 10-12
10.7 Dealing with Unacceptable Results 10-15
10.8 Dealing with Acceptable Results 10-19
10.9 Documenting the Evaluation Process 10-20
10.10 Evaluating Regularity Audit Results 10-21
10.11 Quality Assurance during the Evaluation Phase 10-22
Audit Manual – Table of Contents
iii
11. THE REPORTING PROCESS
11.1 Introduction 11-1
11.2 Focus on the Reporting Process 11-2
11.3 Clearing Observations, Conclusions and Recommendations 11-3
11.4 Obtaining Management Responses 11-4
11.5 Management Representation Letter 11-4
11.6 Audit Completion Checklist 11-6
11.7 Producing the Audit Report 11-8
11.8 Review of Reports by Others 11-9
12. THE AUDIT REPORT
12.1 Introduction 12-1
12.2 The Certification Report and Types of Opinion 12-2
12.3 Audit Reports other than Opinions on Financial Statements 12-8
12.4 Reporting Style And Format 12-10
12.5 Compliance and Performance Reports 12-13
13. DOCUMENTATION AND WORKING PAPERS
13.1 The Need for Documentation and Working Paper Files 13-1
13.2 The Purpose of Working Paper Files 13-1
13.3 The Quality of Working Paper Files 13-2
13.4 Custody and Maintenance of the Working Paper Files 13-5
14. AUDIT FOLLOW UP
14.1 Introduction 14-1
14.2 Timing of the Follow Up 14-2
14.3 Determining the Desired Level of Assurance 14-3
14.4 Performing the Follow Up 14-5
14.5 Reporting the Results of the Follow Up 14-6
14.6 Performing Additional Follow Ups 14-7
15. QUALITY ASSURANCE
15.1 Introduction 15-1
15.2 General Quality Assurance Techniques Described In This Manual
15-1
15.3 Quality Assurance during the Planning Phases for Individual Audits 15-2
15.4 Quality Assurance during the Fieldwork Phase for Individual Audits 15-3
15.5 Quality Assurance during the Evaluation Phase 15-3
15.6 Quality Assurance during the Reporting Phase 15-3
15.7 Quality Assurance during the Follow Up Phase 15-4
15.8 Other Quality Assurance Procedures 15-4
List of Appendices
Appendix A: Glossary of Terms A-1
Appendix B: Statistical and Non-Statistical Sampling and the Use of CAATs B-1
Appendix C: Computer Assisted Auditing Techniques (CAATs) C-1
Appendix D: Assurance and Materiality D-1
Appendix E: Analytical Methods E-1
Appendix F: Interviewing F-1
Cowater File No. 00.622
Project for Improvement of Financial Reporting and Auditing
(PIFRA)
Audit Component – Credit #2921 PAK
AUDIT COMPONENT No. 100
Audit Manual
Prepared for:
The Department of the Auditor-General of Pakistan
Prepared by:
Cowater International Inc., Ottawa, Canada
July 2004
Audit Manual – Chapter 1
1-1
1. ORGANISATION AND PURPOSE OF THE
MANUAL
1.1 Purpose of the Audit Manual
1.1.1 The purpose of this Audit Manual is to provide DAGP auditors with a set of
modern auditing standards, concepts, techniques, and quality assurance
arrangements that are consistent with international standards, for auditing
entities in the Government of Pakistan. The Manual covers the entire audit
cycle from planning to follow up.
1.1.2 This Audit Manual lays out what is expected of the auditors of the
Department of the Auditor-General of Pakistan (DAGP). It provides the
standards by which the audits are to be conducted. It provides guidance
with regard to the methods and approaches to audit that can be applied by
the auditors in carrying out their duties.
1.2 Types of audits dealt with
1.2.1 This Manual focuses on regulatory audit, as defined by INTOSAI Auditing
Standards, which have been adopted by the Department of the Office of the
Auditor-General of Pakistan.
1.2.2 Regulatory audit embraces:
a) Attestation of financial accountability of accountable entities, involving
examination of financial records and expression of opinions on financial
statements;
b) Attestation of financial accountability of the government administration as
a whole;
c) Audit of financial systems and transactions, including an evaluation of
compliance with applicable statutes and regulations;
d) Audit of internal controls and internal audit functions;
e) Audit of the probity and propriety of administrative decisions taken within
the audited entity; and,
f) Reporting of any other matters arising from or relating to the audit that
DAGP considers should be disclosed.
1.3 Audit entities dealt with
1.3.1 DAGP’s mandate includes the audit of federal, provincial and district
government accounts which encompass government ministries, departments
and agencies, self-accounting entities and exempt entities. The types of
entities being audited include financial institutions, commercial entities,
public utilities, and tax-collecting entities.
Modern auditing standards, concepts , techniques, and quality assurance arrangements are consistent with international standards, DAGP’s mandate includes federal, provincial and district government accounts.
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Audit Manual – Chapter 1
1.4 Accounting Responsibility Structure of the
Government of Pakistan
1.4.1 The following is a brief summary of the accounting structure of the
Pakistan government.
a)
Federal government. The Controller General of Accounts (CGA) has
primary responsibility for the completeness and accuracy of the
Federation’s financial statements. Reporting to the CGA, the Accountant
General Pakistan Revenues (AGPR) is responsible for the centralised
accounting and reporting of federal transactions. Additionally the AGPR is
responsible for the consolidation of summarised financial information
prepared by federal self-accounting entities.
b) The AGPR receives accounts and reports from the sub-offices of the AGPR,
district accounts officers, principal accounting officers of self accounting
entities, federal treasuries and the State Bank of Pakistan/National Bank of
Pakistan. The AGPR, in turn, provides annual accounts to the CGA.
c) There are AGPR sub-offices in each of the provinces that act as the district
accounts officers in respect of federal government transactions.
d)
Provincial governments. The CGA also has primary responsibility for the
completeness and accuracy of the financial statements of the provincial
governments.
e) Reporting to the CGA, the accountant general of each province is
responsible for the centralised accounting and reporting functions within
his/her respective province.
f)
District governments. Each province is divided into districts. The district
coordination officer of each district is the principal accounting officer of
that district. The district coordination officer is supported by executive
district officers who, in turn, supervise offices headed by drawing and
disbursing officers.
g) Principal Accounting Officers (PAOs).
Each ministry and department has a
PAO. For the self accounting entities, the PAOs have been delegated
authority to maintain their own accounts. They provide monthly accounting
data to the AGPR and to the accountant generals.
h)
District Accounts Officers (DAOs). The DAOs are responsible for the
accounting functions of the districts. They have authority to pre-audit bills,
issue payments, and record government transactions at the district level.
They receive reports from the drawing and disbursing officers and bank
scrolls from the State Bank of Pakistan/National Bank of Pakistan. They
report district and provincial transactions to the Accountant General
responsible for the province in which their districts are located. They also
report federal transactions to the AGPR.
i)
Departmental treasuries. Departmental treasuries are established to record
specific accounting transactions such as income and sales taxes and
customs duties.
Audit Manual – Chapter 1
1-3
j)
Drawing and Disbursing Officers (DDOs). The DDOs are responsible for
the accounting, cash and personnel functions of specific entities. They
submit bills for pre-audit to the district accounts officers, and report to the
district coordination officer of each district. They also report to the
principal accounting officer of his/her entity.
1.4.2 DAGP’s mandate includes the audit of the entire process described above.
1.5 Stages of audit work dealt with
1.5.1 The manual covers the entire audit cycle for both the financial attestation
and compliance with controls aspects of regulatory audits, including
planning, fieldwork, evaluation of findings, reporting and follow up. While
many of the same procedures apply to both attestation and compliance audit
activities, sometimes different approaches are required to meet specific
audit objectives. Where this is the case, the different approaches are
described. This Manual also deals with such quality assurance techniques
as supervision and review.
1.6 Organisation of the manual
1.6.1 The Manual begins with several Chapters that provide background material
on audits in general, DAGP’s mandate, and the auditing standards adopted
by DAGP.
1.6.2 This is followed by a discussion of DAGP’s management structure and the
annual planning process by which DAGP establishes its departmental goals
and resource needs.
1.6.3 The auditors’ responsibilities through the complete audit cycle - the
planning, fieldwork, evaluation, reporting and follow-up of individual
audits – are presented using a framework adopted, in one form or another,
by many SAIs and private sector audit firms around the world. This
framework integrates the auditing concepts for all phases of the audit.
1.6.4 Throughout the manual, various quality assurance procedures are
introduced. The Manual concludes with a summary of these procedures.
1.6.5 The Manual also contains a number of annexes that provide additional
details and guidance material on specific matters, as well as a glossary of
the terms used.
1.7 Links to other guidance material
1.7.1 This manual is supported by a standard audit working paper kit and a set of
tailored audit programme guides. This Manual also makes reference to
other DAGP documentation in existence at the time that this manual was
produced.
The manual covers the entire Audit Cycle.
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Audit Manual – Chapter 1
1.8 Standard audit working paper kit
1.8.1 The kit includes standard audit programme guides, checklists and forms,
and a table of contents that follows a suggested standard working paper
indexing scheme.
1.8.2 The kit also includes samples of the various supervision instruments used in
DAGP.
1.8.3 Audit guidelines for specialised areas
1.8.4 This Manual and the standard audit working paper kit are applicable to the
regulatory audits of all audit areas. These documents are complemented by
tailored audit programme guides that show how the concepts in the manual,
and the programmes, checklists, forms and supervision instruments in the
working paper kit, are applied to perform financial audits in certain specific
audit areas.
1.9 Need for professional judgment
1.9.1 Despite the detailed guidance presented in this manual, professional
judgment is always required. It is not possible to present guidance material
in sufficient detail to eliminate the need for professional judgment and
general knowledge of auditing theory. Nor is it possible to select one audit
approach and mandate its use in all circumstances.
1.9.2 There are many possible approaches to obtaining the required level of audit
assurance, each appropriate in certain circumstances. The auditor must be
prepared to consider the circumstances of each audit and determine the best
approach.
1.10 Updating the Audit Manual
1.10.1 DAGP’s work, like the work of any SAI, continues to evolve.
Consequently, this Manual should be periodically up-dated to ensure that it
reflects the current policies and procedures of the office and to provide the
most appropriate assistance to the auditors. Each auditor is therefore
encouraged to identify areas in which the Manual requires updating or
enhancement.
1.10.2 With appropriate up-dating, this Manual will continue to provide a clear
statement of the authorities, responsibilities and policies of DAGP and a
practical guide to auditors as they carry out their responsibilities in a
professional and conscientious manner.
Despite the guidance presented in this manual, professional judgement is always required. This manual should be periodically updated to ensure that it reflects the current policies and procedures.
Audit Manual – Chapter 2
2-1
2. ROLE OF THE AUDITOR-GENERAL
2.1 Parliamentary Control and Public Accountability
2.1.1 Accountability of elected officials and the public servants that implement
their policies is a cornerstone of democratic government. In Pakistan, the
government is formed of elected representatives of the people, and is
required by the Constitution to seek a fresh mandate every five years.
2.1.2 To ensure the administrative machinery of the government performs its
functions in accordance with the aspirations of the people, the National
Assembly (lower house of the Parliament) and the four Provincial
Assemblies constitute Standing Committees on Public Accounts (PACs).
The PACs are mandated to oversee the implementation of government
policies and programmes.
2.1.3 The Government departments and agencies are held accountable for any
major departure from the approved budget and for significant violations of
rules and regulations. The Auditor-General of Pakistan reviews the
financial statements submitted by each Government department and agency
and reports findings to the President and Provincial Governors who submit
them to the National and Provincial Assemblies respectively. The
legislatures assign these reports to the PACs for detailed scrutiny. Each
PAC holds hearings at which secretaries of the ministry, divisions and
departments submit their responses to the Auditor-General’s observations.
Based on this testimony, each PAC then makes its recommendations to the
National Assembly. This process ensures that departments and agencies are
accountable to government for implementation of policies in accordance
with regulations.
2.2 Introduction to Auditing
2.2.1 Auditing is the process by which the Auditor-General of Pakistan (or such
officer of the department as may be authorised in this regard by general or
special order) evaluates the financial statements that have been submitted
for audit by the ministries, departments and agencies, against the
government’s accounting and financial administration policies to enable
him to prepare a report or state an opinion on the financial statements.
2.2.2 Section 3.4 of DAGP’s Auditing Standards requires that a financial audit
will include a test of compliance with applicable laws and regulations.
2.2.3 To ensure that an audit has value, it should be conducted in accordance with
generally accepted auditing standards (GAAS). These standards have
developed over many generations of auditors around the world to provide
the basis for ensuring complete, accurate, honest and transparent reporting
of financial operations.
Accountability of elected officials and the public servant is a cornerstone of democratic government. The Auditor-General of Pakistan evaluates the financial statements submitted by ministries, department, and agencies to state an opinion.
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Audit Manual – Chapter 2
2.3 Legislative Basis
2.3.1 The authority under which the Auditor-General of Pakistan conducts audits
is given by Article 169 of the Constitution of the Islamic Republic of
Pakistan. In addition, Articles 168 to 171 also relate to the work of the
Auditor-General.
2.3.2 Until 1 July 2001, most of DAGP’s audit work was performed under
Articles 168 to 171 of the Constitution, and the Pakistan (Audit and
Accounts) Order, 1973.
2.3.3 Effective 1 July 2001, the Pakistan (Audit and Accounts) Order, 1973 was
replaced by the following two ordinances:
a) Auditor-General’s (Functions, Powers and Terms and Conditions of
Service) Ordinance, 2001 (Auditor-General Ordinance); and
b) Controller General of Accounts (Appointment, Functions and Powers)
Ordinance, 2001 (Controller General Ordinance).
2.3.4 Among other things, these ordinances elaborate on the functions, powers
and responsibilities of the Auditor-General of Pakistan in line with the
provisions of Article 169 of the Constitution.
2.3.5 Section 7 of the Auditor-General’s (Functions, Powers and Terms and
Conditions of Service) Ordinance, 2001 (Auditor-General Ordinance) states
that
“The Auditor-General shall, on the basis of such audit as he may
consider appropriate and necessary, certify the accounts” … “of the
Federation, of each Province and of each district”
. A financial attestation
audit leads to the certifications called for in Section 7 of the Auditor-
General Ordinance.
2.3.6 In addition, Section 8 of the Auditor-General Ordinance mandates an audit
of expenditures of the Federation and of each province and Section 12 of
the Auditor-General Ordinance mandates an audit of the receipts of the
Federal Government and of each Province and each district.
The Constitution of
the Islamic Republic
of Pakistan, Articles
168 to 171 relate to
the work of the
Auditor-General.
Audit Manual – Chapter 2
2-3
2.4 Vision, Mission and Values
2.4.1 DAGP has developed a set of guiding principles for the exercise of its
mandate. These principles – the Vision, Mission and Values - are as
follows:
2.4.2 The Vision of DAGP is to add value to public resources.
2.4.3 The Mission of DAGP is to develop our auditing and accounting
capabilities to establish ourselves as a credible professional institution that
promotes good governance and public accountability.
2.4.4 The Values held by DAGP are:
a)
Accountability. DAGP holds itself accountable for the achievement of its
vision, mission, and these stated values.
b)
Professionalism. DAGP conducts all of its activities in an open, transparent,
disciplined and highly ethical manner that is worthy of professional respect
and trust.
c)
Integrity. DAGP takes an objective, fair, honest and balanced approach to
all of its activities.
d)
Excellence. DAGP strives for excellence in all of its activities.
e)
Reliability. DAGP produces high quality products that are timely, accurate,
useful, clear and candid.
f)
Cooperative and constructive spirit. DAGP works with parliamentarians
and with its audit entities, staff, suppliers, consultants and other parties with
whom it deals in a professional, cooperative and constructive manner.
g)
Innovative spirit. DAGP constantly looks for ways to improve its audit
practices, operations and other activities.
h)
Making a difference. DAGP constantly looks for ways to improve the
operations of the entities that it audits.
i)
Risk managers. DAGP managers and staff are encouraged to accept
challenges, and to take and manage the risks required for DAGP to achieve
its vision, mission and stated values.
j)
Open communications. DAGP maintains open and timely communications
with parliamentarians and with its audit entities, staff, suppliers, consultants
and other parties with whom it deals.
k)
A respectful workplace. DAGP provides a workplace in which a diverse
workforce can strive for excellence and professional competence, and
Audit Manual – Chapter 3
3-1
3. THE JOB OF THE AUDITOR
3.1 Introduction
3.1.1 The auditor is a professional with a special role to play in ensuring the
integrity of the operations of the Government of Pakistan and safeguarding
its assets. As such the auditor must fulfill certain expectations with respect
to performance of duties and ethical conduct. The auditor is employed
pursuant to a set of formal conditions and should expect appropriate
protection in the fulfillment of his or her responsibilities. These issues are
outlined below.
3.2 Expectations
3.2.1 Auditors work in teams. Audit teams perform their work in accordance
with DAGP’s Auditing Standards, which are described in detail in Chapter
4. The audit teams should fulfil a number of general expectations in
performing their duties:
a) At least one auditor within the audit team should be fully conversant with
the rules and regulations concerning the accounts to be audited.
b) The audit team should subject the audit entity to a complete and thorough
check according to the audit programme within the constraints of the time
available. Any failure to complete the prescribed audit programme must be
reported clearly and fully to the Audit Manager.
c) Each auditor is expected to use professional judgment in carrying out all
aspects of an audit programme.
d) Although it is not the responsibility of the auditor to detect fraud, every
auditor is expected to take appropriate action wherever a situation of fraud
is suspected.
3.3 Conditions of Employment
3.3.1 The conditions of employment of auditors within DAGP have been
formally and extensively documented in the Auditor-General’s Manual of
Standing Orders. Please refer to the Manual of Standing Orders for details.
3.4 Code of Ethics
3.4.1 Concept, Background and Purpose of the Code of Ethics
3.4.2 The Auditor General of Pakistan (AGP) has deemed it essential to establish
a Code of Ethics for auditors in the public sector.
a) This Code of Ethics is a comprehensive statement of the values and
principles which should guide the daily work of auditors. The
The auditor must
fulfil certain
expectations with
respect to
performance of
duties and ethical
conduct.
3-2
Audit Manual – Chapter 3
independence, powers and responsibilities of the public sector auditor place
high ethical demands on the Department of the Auditor General of Pakistan
and the staff deployed on audit work. This code of ethics for auditors in the
public sector outlines the ethical precepts of civil servants in general and
the particular requirement of auditors, including the latter’s professional
obligations.
b) With the Lima Declaration of Guidelines on Auditing Precepts as its
foundation, this Code of Ethics should be seen as a necessary complement,
reinforcing the Auditing Standards issued by the Auditor General of
Pakistan in June 2002 in line with INTOSAI Code of Ethics and Auditing
Standards.
c) The Code Ethics is directed at the individual auditor, the Auditor-General
of Pakistan, executive officers and all individuals working for or on behalf
of the AGP who are involved in audit work.
d) It is the responsibility of the AGP to ensure that all its auditors acquaint
themselves with the values and principles contained in this Code of Ethics
and act accordingly.
e) The conduct of auditors should be beyond reproach at all times and in all
circumstances. Any deficiency in their professional conduct or any
improper conduct in their personal life places the integrity of auditors, The
Department of AGP that they represent, and the quality and validity of their
audit work, in an unfavourable light, and may raise doubts about the
reliability and competence of the Department of the AGP itself. This code
of ethics for auditors should promote trust and confidence in the auditors
and their work.
f) It is of fundamental importance that the Department of the AGP is looked
upon with trust, confidence and credibility. The auditor promotes this by
adopting and applying the ethical requirements of the concepts embodied in
the key words Integrity, Independence and Objectivity, Confidentiality and
Competence.
3.4.3 Trust, Confidence and Credibility
3.4.4 The legislative and/or executive authority, the general public and the
audited entities are entitled to expect the conduct and approach of the
officers and the staff of the Department of the AGP to be above suspicion
and reproach and worthy of respect and trust.
a) Auditors should conduct themselves in a manner which promotes cooperation
and good relations among themselves and within the profession.
The support of the profession by its members and their co-operation with
one another are essential elements of professional character. The public
confidence and respect that an auditor enjoys is largely the result of the
cumulative accomplishments of all auditors, past and present. It is therefore
The general public
and the audited
entities expect the
conduct and
approach of the
officers of the
Department of the
AGP to be above
suspicion and
reproach
Audit Manual – Chapter 3
3-3
in the interest of auditors, and the public, for auditors to conduct themselves
in a fair and balanced way.
b) The legislative and/or executive authority, the general public and the
audited entities should be fully assured of the fairness and impartiality of all
the work the Department of the AGP.
c) In all parts of society there is a need for credibility. It is therefore essential
that the reports and opinions of the Department of the AGP are considered
to be thoroughly accurate and reliable by knowledgeable third parties.
d) All work performed by the Department of the AGP must stand the test of
legislative and executive scrutiny, public judgments on propriety, and
examination against this Code of Ethics.
3.4.5 Integrity
a) Integrity is the core value of this Code of Ethics. Auditors have a duty to
adhere to high standards of behaviour (e.g. honesty and candidness) in the
course of their work and in their relationships with the staff of audited
entities. In order to sustain public confidence, the conduct of auditors
should be above suspicion and reproach.
b) Integrity, including financial, moral, and intellectual integrity, can be
measured in terms of what is right and just. Integrity requires auditors to
observe both the form and the spirit of auditing and ethical standards.
Integrity also requires auditors to observe the principles of independence
and objectivity, maintain irreproachable standards professional conduct,
make decisions with the public interest in mind, and apply absolute honesty
in carrying out their work and in handling the resources of the Department
of the AGP.
3.4.6 Independence, Objectivity and Impartiality
a) Independence from the audited entity and other outside interest groups is
indispensable for auditors. This implies that auditors should behave in a
way that increases, or in no way diminishes, their independence.
b) Auditors should strive not only to be independent of audited entities and
other interested groups, but also to be objective in dealing with the issues
and topics under review.
c) It is essential that auditors are independent and impartial, not only in fact
but also in appearance.
d) In all matters relating to the audit work, the independence of auditors
should not be impaired by personal or external influence. Independence
may be impaired, for example, by external pressure or influence on auditors;
prejudices held by auditors about individuals, audited entities, projects or
programmes; recent previous employment with the audited entity; or
Auditors have a
duty to adhere to
high standards of
behaviour and to be
above suspicion and
reproach
Auditors should be
independent and
objective.
3-4
Audit Manual – Chapter 3
personal or financial dealings which might cause conflicts of loyalties or of
interests. Auditors have an obligation to refrain from becoming involved in
all matters in which they have a vested interest.
e) There is need for objectivity and impartiality in all work conducted by
auditors, particularly in their reports, which should be accurate and
objective. Conclusions in opinions and reports should, therefore, be based
exclusively on evidence obtained and assembled in accordance with the
auditing standards of the Department of the AGP.
f) Auditors should make use of information brought forward by the audited
entity and other parties. This information is to be taken into account in the
opinions expressed by the auditors in an impartial way. The auditor should
also gather information about the views of the audited entity and other
parties. However, the auditor’s own conclusions should not be affected by
such views.
3.4.7 Political neutrality
a) It is important to maintain both the actual and perceived political neutrality
of the Department of the AGP. Therefore, it is important that auditors
maintain their independence from political influence in order to discharge
their audit responsibilities in an impartial way. This is relevant for auditors
since Department of the AGP works closely with the legislative authorities,
which is empowered by law to consider the reports of the AGP.
3.4.8 Conflicts of Interest
a) When auditors are permitted to provide advice or services other than audit
to an audited entity, care should be taken that these services do not lead to a
conflict of interest. In particular, auditors should ensure that such advice or
services do not include management responsibilities or powers, which must
remain firmly with the management of the audited entity.
b) Auditors should protect their independence and avoid any possible conflict
of interest by refusing gifts or gratuities that could influence or be perceived
as influencing their independence and integrity. Government servants,
Conduct Rules, 1964 shall also apply in this regard.
c) Auditors should avoid all relationships with managers and staff in the
audited entity and other parties that may influence, compromise or threaten
the ability of auditors to act and be seen to be acting independently.
d) Auditors should not use their official position for private purposes and
should avoid relationships that involve the risk of corruption or may raise
doubts about their objectivity and independence.
e) Auditors should not use information received in the performance of their
duties as a means of securing personal benefit for themselves or for others.
It is important to
maintain political
neutrality f the
Department of the
AGP.
Auditors should
not be involved in
management
decisions or
activities.
Audit Manual – Chapter 3
3-5
Neither should they divulge information that would provide unfair or
unreasonable advantage to other individuals or organisations, nor should
they use such information as means for harming others.
3.4.9 Professional Secrecy
a) Auditors should not disclose information obtained in the auditing process to
third parties, either orally or in writing, except for the purposes of meeting
the statutory or other identified responsibilities of the Department of the
AGP as part of its normal procedures or in accordance with relevant laws.
3.4.10 Competence
a) Auditors have a duty to conduct themselves in a professional manner at all
times and to apply high professional standards in carrying out their work to
enable them to perform their duties competently and with impartiality.
b) Auditors must not undertake work they are not competent to perform.
c) Auditors should know and follow applicable auditing, accounting, and
financial management standards, policies, procedures and practices.
Likewise, they must possess a good understanding of the constitutional,
legal and institutional principles and standards governing the operations of
the audited entity.
3.4.11 Professional Development
3.4.12 Auditors should exercise due professional care in conducting and
supervising the audit and in preparing related reports.
a) Auditors should use methods and practices of the highest possible quality in
their audits. In the conduct of the audit and the issue of reports, auditors
have a duty to adhere to basic principles and generally accepted auditing
standards.
b) The Department of the AGP has a continuous obligation to update and
improve the skills of officers and staff in the discharge of their professional
responsibilities.
3.5 Glossary
3.5.1 The terms used in this Code of Ethics have the same interpretation or
definition as those used in the Auditing Standards.
3.6 Protection of the Auditor
3.6.1 Auditors must have the freedom to carry out audits in a conscientious and
thorough manner. There is an onus on the auditor to carry out the audits in
Auditors should not
disclose information
obtained in the
auditing process.
Auditors should
know auditing,
accounting, and
financial
management
standards, policies,
procedures and
practices.
3-6
Audit Manual – Chapter 3
a fair, objective and courteous manner (and comply with the Code of Ethics
presented in the Section above). In turn, the auditor expects to receive
cooperation and courtesy from those being audited.
3.6.2 Any serious attempts to hinder or impede the conduct of the audit should be
brought to the attention of the Audit Manager. Any concern of possible
intimidation or threat to the auditor must be taken seriously both by the
auditor and the management of DAGP. A formal process should be
followed wherever the auditor, or the conduct of the audit, is threatened, or
a risk of impedance is perceived. This process involves the following steps:
a) Whenever the auditor senses any problems in the conduct of the audit,
he/she should ensure that all meetings are held with at least two auditors
present and that notes of these meetings are clearly documented;
b) The auditor should inform his/her supervisor or Audit Manager in writing
of any serious incidents or concerns with specific details of what transpired;
c) A course of action is proposed by the Audit Manager, if necessary, in
consultation with senior management within DAGP;
d) Depending on the seriousness of the situation, and the nature of the problem,
one or more of the following courses of action should be implemented:
- The Audit Manager raises the issue with the Principal Accounting
Officer, or equivalent;
- A letter, signed by the Auditor-General or Deputy Auditor-General, is
submitted to the Principal Accounting Officer, or equivalent, and/or sent
to the Controller General;
- The composition of the audit team is changed;
- If necessary, after consultation with the Auditor-General, seek a legal
opinion or other course of action; and
- Whenever an individual auditor is not satisfied with the action taken, they
have the right to report their concern to the Assistant Auditor-General,
Personnel, a Deputy Auditor-General or the Auditor-General.
Attempts to hinder
or impede the
conduct of the audit
should be brought to
the attention of the
Audit Manager
Audit Manual – Chapter 4
4-1
4. DAGP AUDIT STANDARDS
4.1 Basic Principles in Government Auditing
4.1.1 The general framework of the auditing standards of the Auditor General of
Pakistan is based on the principles of the latest INTOSAI Auditing
Standards.
4.1.2 The INTOSAI auditing standards consist of four parts.
a) Basic principles
b) General standards
c) Field standards
d) Reporting standards
4.1.2 These standards have been developed to provide a framework for the
establishment of procedures and practices to be followed in the conduct of
an audit, including audits of computer-based systems. They should be
viewed in the context of the particular constitutional and legal provisions
applicable to the Department of the Auditor General of Pakistan.
4.1.3 The basic principles for auditing standards are basic assumptions,
consistent premises, logical principles and requirements which help in
developing auditing standards and serve the auditors in forming their
opinions and reports, particularly in cases where no specific standards
apply.
4.1.4 Auditing standards should be consistent with the principles of auditing:
They also provide guidance for the auditor that helps determine the extent
of auditing steps and procedures that should be applied in the audit.
Auditing Standards constitute the criteria or yardsticks against which the
quality of the audit results are evaluated.
4.1.5 Interpretations, explanation and amendments of these standards are the
prerogative and responsibility of the AGP.
4.1.6 The basic principles are:
a) The Department of the AGP will ensure compliance with the auditing
standards in all matters that are deemed material. These standards will be
applied to ensure that the work is of consistently high quality.
b) The Department of the AGP shall apply its own judgment to the diverse
situations that arise in the course of government auditing (see paragraph
4.1.14)
c) With increased public consciousness, the demand for public accountability
of persons or entities managing public resources has become increasingly
evident so that there is a need for the accountability process to be in place
and operating effectively (see paragraph 4.1.19)
Audit standards
provide a framework
to be followed in the
conduct of an audit.
Ensure compliance
with auditing
standards.
Apply judgement.
4-2
Audit Manual – Chapter 4
d) Development of adequate information, control, evaluation and reporting
systems within the government will facilitate the accountability process.
Management is responsible for correctness and sufficiency of the form and
content of the financial reports and other information (see paragraph 4.1.21)
e) Appropriate authorities should ensure the promulgation of acceptable
accounting standards for financial reporting and disclosure relevant to the
need of the government, and audited entities should develop specific and
measurable objectives and performance targets (see paragraph 4.1.23)
f) Consistent application of acceptable accounting standards should result in
the fair presentation of the financial position and the results of operations
(see paragraph 4.1.26)
g) The existence of an adequate system of internal control minimises the risk
of errors and irregularities (see paragraph 4.1.28)
h) Legislative enactments would facilitate the co-operation of audited entities
in maintaining and providing access to all relevant data necessary for a
comprehensive assessment of the activities under audit (see paragraph
4.1.30)
i) All audit activities should be within the audit mandate of the Auditor
General of Pakistan (see paragraph 4.1.32)
j) The Department of the AGP shall work towards improving techniques for
auditing the validity of performance measures (see paragraph 4.1.41)
4.1.7 The following paragraphs discuss the importance of the basic principles for
auditing.
4.1.8 The basic auditing principles stipulate that:
The Department of the AGP shall ensure compliance of the auditing
standards in all matters that are defined as material. These standards will be
applied to ensure that the work is of consistently high quality.
4.1.9 In general terms, a matter may be judged material if knowledge of it would
be likely to influence the user of the financial statements or the performance
audit report.
4.1.10 Materiality is often considered in terms of value but the inherent nature or
characteristics of an item or group of items may also render a matter
material—for example, where the law or regulation requires it to be
disclosed separately regardless of the amount involved.
4.1.11 In addition to materiality by value and by nature, a matter may be material
because of the context in which it occurs. For example, considering an item
in relation to:
a) The overall view given to the financial information;
Audit Manual – Chapter 4
4-3
b) The total of which it forms a part;
c) Associated terms and issues;
d) The corresponding amount in previous years.
4.1.12 Sometimes the Department of the AGP carries out activities that by strict
definition do not qualify as audits, but which contribute to better
government, e.g., (a) gathering data without conducting substantial analysis,
(b) legal work, (c) an assistance mission for members of the elected
Assemblies as regards investigations and consultations of files of the
Department of the AGP. These non-audit activities provide valuable
information to decision-makers and should be of consistently high quality.
4.1.13 To ensure that high quality work is done, appropriate standards must be
followed. The objectives of the particular type of work or the particular
assignment should dictate the specific standards that are followed. The
Department of the AGP shall establish a policy for implementing these
standards to ensure that the work and products are of high quality.
4.1.14 The basic auditing principles stipulate that:
The Department of the AGP shall apply its own judgment to the diverse
situations that arise in the course of government auditing (see paragraph
4.1.6b)
4.1.15 Audit evidence plays an important part in the auditor’s decision concerning
the selection of issues and areas for the audit and the nature, timing and
extent of audit tests and procedures.
4.1.16 The terms of the audit mandate with which the Department of the AGP is
endowed override any accounting or auditing conventions with which they
conflict, and hence have a crucial bearing on the auditing standards that the
Department applies.
4.1.17 The Department of the AGP must judge the extent to which external
auditing standards are compatible with the fulfilment of its mandate.
4.1.18 For some elements of the mandate of the AGP, particularly in regard to the
audit of financial statements, the audit objectives may be akin to the
objectives of audits in the private sector. Correspondingly, private sector
standards for the financial statements auditing which are promulgated by
official regulatory bodies might be applicable to the government auditor.
4.1.19 The basic auditing principles stipulate that:
With increased public consciousness, the demand for the public
accountability of persons or entities managing resources has become
increasingly evident so that there is a greater need for the accountability
process to be in place and operating effectively (see paragraph 4.1.6c)
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Audit Manual – Chapter 4
4.1.20 Public enterprises are also required to fulfil public accountability
obligations. Public enterprises may include commercial undertakings, e.g.
entities established by statute or executive order or in which the
Government has a controlling interest. Irrespective of the manner in which
they are constituted, their functions, degree of autonomy or funding
arrangements, such entities are ultimately accountable to the respective
legislature.
4.1.21 The basic auditing principles stipulate that:
Development of adequate information, control, evaluation and reporting
systems within the government will facilitate the accountability process.
Management is responsible for correctness and sufficiency of the form and
content of the financial reports and other information (see paragraph 4.1.6d)
4.1.22 The correctness and sufficiency of the financial reports and statements are
the entity’s expression of the financial position and the results of operations.
It is also the entity’s obligation to design a practical system which will
provide relevant and reliable information.
4.1.23 The basic auditing principles stipulate that:
Appropriate authorities should ensure the promulgation of acceptable
accounting standards for financial reporting and disclosure relevant to the
needs of the government, and audited entities should develop specific and
measurable objectives and performance targets (see paragraph 4.1.6e)
4.1.24 The Department of the AGP shall work with the accounting standards
setting organisations to help ensure that proper accounting standards are
issued for the government.
4.1.25 The Department of the AGP shall also recommend to the audited entities
that measurable and clearly stated objectives be established and that
performance targets be set for these objectives.
4.1.26 The basic auditing principles stipulate that:
Consistent application of acceptable accounting standards should result in
the fair presentation of the financial position and the results of operations
(see paragraph 4.1.6f)
4.1.27 The assumption that consistency in application of accounting standards is a
prerequisite of fairness means that an audited entity must comply with
accounting standards appropriate in the circumstances, as well as the
requirements of applying such accounting standards in a consistent manner.
An auditor should not consider compliance with accounting standards in a
consistent manner as a definitive proof of presenting fairly the various
financial reports. Fairness is an expression of an auditor’s opinion that goes
beyond the limits of consistent application of accounting standards. Such an
assumption emphasises that the auditing standards are no more than the
minimum requirements for an auditor’s obligation. Going beyond that
minimum is for the auditor’s judgment.
Audit Manual – Chapter 4
4-5
4.1.28 The basic auditing principles stipulate that:
The existence of an adequate system of internal control minimises the risk
of errors or irregularities (see paragraph 4.1.6g)
4.1.29 It is the responsibility of the audited entity to develop adequate internal
control systems to protect its resources. It is not the auditor’s responsibility.
It is also the obligation of the audited entity to ensure that controls are in
place and functioning to help ensure that applicable statutes and regulations
are complied with, and that probity and propriety are observed in decision
making. However, this does not relieve the auditor from submitting
proposals and recommendations to the audited entity where controls are
found to be inadequate or missing.
4.1.30 The Basic auditing principles stipulate that:
Legislative enactments would facilitate the co-operation of audited entities
in maintaining and providing access to all relevant data necessary for a
comprehensive assessment of the activities under audit (see paragraph
4.1.6h)
4.1.31 The Department of the AGP must have access to the sources of information
and data as well as access to officials and employees of the audited entity in
order to carry out properly its audit responsibilities. Enactment of
legislative requirements for access by the auditor to such information and
personnel will help minimise future problems in this area.
4.1.32 The basic auditing principles stipulate that:
All audit activities should be within the audit mandate of the AGP (see
paragraph 4.1.6i)
4.1.33 The essential function of the department of the AGP is to uphold and
promote public accountability. This jurisdictional function requires the
Department to make sure that whoever is charged with dealing with public
funds is accountable to it and is in this regard subject to its jurisdiction.
4.1.34 There exists an important complementarity between this jurisdictional
authority and the other characteristics of audit. This characteristic should be
viewed as a part of the logic of the general objective pursued by external
audit and more particularly those which relate to accounting management.
4.1.35 The full scope of government auditing includes regularity and performance
audit.
4.1.36 Regularity audit embraces:
a) Attestation of financial accountability of accountable entities, involving
examination and evaluation of financial records and expression of opinions
of financial statements;
b) Attestation of financial accountability of the government administration as
a whole;
4-6
Audit Manual – Chapter 4
c) Audit of financial systems and transactions including an evaluation of
compliance with applicable statutes and regulations;
d) Audit of internal control and audit functions;
e) Audit of the probity of administrative decisions taken within the audited
entity; and
f) Reporting of any other matters arising from or relating to the audit that the
Department of the AGP considers should be disclosed.
4.1.37 Performance audit is concerned with the audit of economy, efficiency and
effectiveness and embraces:
a) Audit of the economy of administrative activities in accordance with sound
administrative principle and practices, and management policies;
b) Audit of the efficiency of utilisation of human, financial and other resources,
including examination of information systems, performance measures and
monitoring arrangements, and procedures followed by audited entities for
remedying identified deficiencies; and
c) Audit of the effectiveness of performance in relation to the achievement of
the objectives of the audited entity, and audit of the actual impact of
activities compared with the intended impact.
4.1.38 In practice there can be an overlap between regularity and performance
auditing, and in such cases classification of a particular audit will depend
on the primary purpose of that audit.
4.1.39 The mandate of the Department of the AGP shall clearly delineate its
powers and responsibilities in relation to performance auditing in all areas
of government activity, among other things to facilitate the application of
appropriate auditing standards.
4.1.40 Public accountability will be more effectively promoted where the mandate
enables the SAI to conduct, or direct the conduct of, regularity and
performance auditing of all public enterprises.
4.1.41 The general auditing principles stipulate that:
The Department of the AGP shall work towards improving techniques for
auditing the validity of performance measures (see paragraph 4.1.6j)
4.1.42 The expanding audit role of the auditors will require them to improve and
develop new techniques and methodologies to assess whether reasonable
and valid performance measures are used by the audited entity. The auditors
should avail themselves of techniques and methodologies of other
disciplines.
4.1.43 The scope of the audit mandate will determine the scope of the standards to
be applied by the Department of the AGP.
Audit Manual – Chapter 4
4-7
4.2 General standards in Government Auditing
4.2.1 This section deals with general standards in government auditing. The
general auditing standards describe the qualifications of the auditor
and/or the auditing institution so that they may carry out the tasks related
to field and reporting standards in a competent and effective manner.
4.2.2 The general auditing standards are that the Department of the AGP shall
adopt policies and procedures to:
a) Recruit personnel with suitable qualifications (see paragraph 4.2.3)
b) Develop and train employees of the Department of the AGP to enable
them to perform their tasks effectively, and to define the basis for the
advancement of auditors and other staff (see paragraph 4.2.5)
c) Prepare manual and other written guidance and instructions concerning
the conduct of audit (see paragraph 4.2.13).
d) Support the skills and experience available within the Department of the
AGP and identify the skills which are absent; provide a good distribution
of skills to auditing tasks and assign a sufficient number of persons for
the audit; and have proper planning and supervision to achieve its goals at
the required level of due care and concern (see paragraph 4.2.15)
e) Review the efficiency and effectiveness of the Department internal
standards and procedures (see paragraph 4.2.25)
4.2.3 The general standards for Department of the AGP include:
The Department shall frame policies and develop procedures to recruit
personnel with suitable qualifications (see paragraph 4.2.2a)
The following paragraph explains recruitment as an auditing standard.
4.2.4 Personnel of the Department of the AGP shall possess suitable academic
qualifications and be equipped with appropriate training and experience.
The Department shall establish, and regularly review, minimum educational
requirements for the appointment of auditors.
4.2.5 The general standards include:
The Department shall frame policies and procedures to develop and train its
employees to enable them to perform their tasks effectively and to define
the basis for the advancement of auditors and other staff (see paragraph
4.2.2b)
The following paragraphs explain training and development as an auditing
standard.
4.2.6 The Department shall take adequate steps to provide for continuing
professional development of its personnel, including, as appropriate,
4-8
Audit Manual – Chapter 4
provision of in-house training and encouragement of attendance at external
courses.
4.2.7 The Department shall maintain an inventory of skills of personnel to assist
in the planning of audits as well as to identify professional development
needs.
4.2.8 The Department shall establish and regularly review criteria, including
educational requirements, for the advancement of auditors and other staff of
the SAI.
4.2.9 The Department shall also establish and maintain policies and procedures
for the professional development of audit staff regarding the audit
techniques and methodologies applicable to the range of audits it
undertakes.
4.2.10 Personnel of the Department of the AGP shall have a good understanding
of the government environment, including such aspects as the role of the
legislature, the legal and institutional arrangements governing the
operations of the executive and the charters of the public enterprises.
Likewise, trained audit staff must possess an adequate knowledge of the
Department’s auditing standards, policies, procedures and practices.
4.2.11 Audit of financial systems, accounting records and financial statements
requires training in accounting and related disciplines as well as a
knowledge of applicable legislation and executive orders affecting the
accountability of the audited entity. Further, the conduct of performance
audits may require, in addition to the above, training in such areas as
administration, management, economics and the social sciences.
4.2.12 The Department shall encourage its personnel to become members of a
professional body relevant to their work and to participate in that body’s
activities.
4.2.13 The general standards include:
The Department shall adopt policies and develop procedures to prepare
manuals and other written guidance and instructions concerning the conduct
of audits (see paragraph 4.2.2c)
The following paragraph explains written guidance as an auditing standard
.
4.2.14 Communication to staff of the Department of the AGP by means of
circulars containing guidance, and the maintenance of an up-to-date audit
manual setting out its policies, standards and practices, is important in
maintaining the quality of audits.
4.2.15 The general standards include:
The Department shall frame policies and develop procedures to support the
skills and experience available within the Department and identify those
skills which are absent; provide a good distribution of skills to auditing
Audit Manual – Chapter 4
4-9
tasks and a sufficient number of persons for the audit and have proper
planning and supervision to achieve its goals at the required level of due
care and concern (see paragraph 4.2.2d)
The following paragraphs explain the use of skills as an auditing standard.
4.2.16 Resources required to undertake each audit need to be assessed so that
suitably skilled staff may be assigned to the work and a control placed on
staff resources to be applied to the audit.
4.2.17 The extent to which academic attainment should be related specifically to
the audit task varies with the type of auditing undertaken. It is not necessary
that each auditor possess competence in all aspects of the audit mandate.
However, policies and procedures governing the assignment of personnel to
audit tasks should aim at deploying personnel who have the auditing skills
required by the nature of the audit task so that the team involved on a
particular audit collectively possesses the necessary skills and expertise.
4.2.18 It shall be open to the Department of the AGP to acquire specialised skills
from external sources if the successful carrying out of an audit so requires
in order that the audit findings, conclusions and recommendations are
perceptive and soundly based and reflect an adequate understanding of the
subject area of the audit. It is for the Department of the AGP to judge, in its
particular circumstances, to what extent its requirements are best met by inhouse
expertise as against employment of outside experts.
4.2.19 Policies and procedures governing supervision of audits are important
factors in the performance of the SAI’s role at an appropriate level of
competence. The Department of the AGP shall ensure that audits are
planned and supervised by auditors who are competent, knowledgeable in
the standards and methodologies, and equipped with an understanding of
the specialities and peculiarities of the environment.
4.2.20 For the audit of financial statements which cover the executive branch of
government as a whole, the audit teams deployed shall be equipped to
undertake a co-ordinated evaluation of departmental accounting systems, as
well as of central agency co-ordination arrangement and control
mechanisms. Teams will require a knowledge of the relevant government
accounting and control systems, and an adequate expertise in the auditing
techniques applied by the Department to this type of audit.
4.2.21 Unless the Department is equipped to undertake, within a reasonable timescale,
all relevant audits, including performance audits covering the whole
of every audited entity’s operations, criteria shall be needed for determining
the range of audit activities which, within the audit period or cycle, will
give the maximum practicable assurance regarding performance of public
accountability obligations by each audited entity.
4.2.22 In determining the allocation of its resources among different audit
activities, the Department shall give priority to any audit tasks which must,
by law, be completed within a specified time frame. Careful attention shall
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Audit Manual – Chapter 4
be given to strategic planning so as to identify an appropriate order of
priority for discretionary audits to be undertaken.
4.2.23 Assignment of priorities compatible with maintaining the quality of
performance across the mandate involve the exercise of judgment by the
Department of the AGP in the light of available information. Maintenance
of a portfolio of data pertaining to the structure, functions and operations of
audited entities will assist the department in identifying areas of materiality
and vulnerability and areas holding potential for improvements in
administration.
4.2.24 Before each audit is undertaken proper authorisation for its commencement
shall be given by designated personnel within the Department of the AGP.
This authorisation shall include a clear statement of the objectives of the
audit, its scope and focus, resources to be applied to the audit in terms of
skills and quantum, arrangements for reviews of progress at appropriate
points, and the dates by which fieldwork is to be completed and a report on
the audit is to be provided.
4.2.25 The general standards include:
The Department of the AGP shall frame polices and develop procedures to
review the efficiency and effectiveness of its internal standards and
procedures (see paragraph 4.2.2e)
The following paragraphs explain quality assurance reviews as an auditing
standard.
4.2.26 Because of the importance of ensuring a high standard of work by the
Department of the AGP it shall pay particular attention to quality assurance
programmes in order to improve audit performance and results. The
benefits to be derived from such programmes make it essential for
appropriate resources to be available for this purpose. It is important that
the use of these resources be matched against the benefits to be obtained.
4.2.27 The Department of the AGP shall establish systems and procedures to:
a) Confirm that integral quality assurance processes have operated
satisfactorily.
b) Ensure the quality of the audit report; and
c) Secure improvements and avoid repetition of weaknesses.
4.2.28 As a further means of ensuring quality of performance, additional to the
review of audit activity by personnel having line responsibility for the
audits concerned, the Department shall establish its own quality assurance
arrangements. That is, planning, conduct and reporting in relation to a
sample of audits may be reviewed in depth by suitably qualified personnel
of the Department not involved in those audits, in consultation with the
relevant audit line management regarding the outcome of the internal
quality assurance arrangements and periodic reporting to the top
management of the Department.
Audit Manual – Chapter 4
4-11
4.2.29 It is appropriate for the Department of the AGP to institute their own
internal audit function with a wide charter to assist it to achieve effective
management of its own operations and sustain the quality of its
performance.
4.2.30 The quality of the work of the Department shall be enhanced by
strengthening internal review and by independent appraisal of its work.
4.2.31 The Department shall ensure that applicable standards are followed on all
audits and that deviations from the standards which are determined to be
appropriate are documented.
4.3 Standards with Ethical Significance
4.3.1 The general auditing standards include:
a) The auditor and the Department of the AGP must be independent (see
paragraph 4.3.2)
b) The Department of the AGP shall avoid conflict of interest between the
auditor and the entity under audit (see paragraph 4.3.28)
c) The auditor and the Department of the AGP must possess the required
competence (see paragraph 4.3.30)
d) The auditor and the department of the AGP must exercise due care and
concern in complying with these auditing standards. This embraces due
care in planning, specifying, gathering and evaluating evidence, and in
reporting findings, conclusions and recommendations (see paragraph 4.3.36)
Independence
4.3.2 The general standards for the auditor and the Department of the AGP
include:
The auditor and the Department must be independent (see paragraph 4.3.1a)
The following paragraphs explain independence as an auditing standard.
In particular, paragraphs 4.3.4 – 4.3.11 explain independence from the
legislature, paragraphs 4.3.12 – 4.3.21 from the executive, and paragraphs
4.3.22 – 4.3.26 from the audited entity.
4.3.3 Whatever the form of government, the need for independence and
objectivity in audits is vital. An adequate degree of independence from both
the legislature and the executive branch of government is essential to the
conduct of audit and to the credibility of its results.
4.3.4 The legislature is one of the main users of the services of the Department of
the Auditor General of Pakistan. It is from the Constitution and the
legislation that the SAI derives its mandate, and a frequent feature of the
Department’s function is its reporting to the legislature. The SAI can be
expected to work closely with the legislature, including with any
committees empowered by the legislature to consider its reports. Such
liaison can contribute to effective follow-up of the Department’s work.
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Audit Manual – Chapter 4
4.3.5 The important results of audits of the carrying-out of the budget and of
administration and disputes and disagreements with audited administrations
shall be brought to the attention of the legislative body by way of report or
special communication.
4.3.6 Special committees created within the legislative body may be charged with
examining, in the presence of delegates from the audited services and other
representatives, the comments in the reports and special communications of
the Department of the AGP.
4.3.7 The Department of the AGP may give members of the legislature factual
briefings on audit reports, but it is important that it maintains its
independence from political influence, in order to preserve an impartial
approach to its audit responsibilities. This implies that the Department of
the AGP shall not be responsive, nor give the appearance of being
responsive, to the wishes of particular political interests.
4.3.8 While the Department of the AGP observes the laws enacted by the
legislature, adequate independence requires that it not otherwise be subject
to direction by the legislature in the programming, planning and conduct of
its work in accordance with its mandate and adopt methodologies
appropriate to audits. The Department of the AGP needs freedom to set
priorities and programme the audits to be undertaken.
4.3.9 In cases where the legislature requests the AGP to undertake any audit, the
Department of the AGP shall be free to determine the manner in which it
conducts its work, including those tasks requested by the legislature.
4.3.10 It is appropriate for the legislation to specify minimum reporting
requirements, including the matters to be subject to an audit opinion and a
reasonable time within which reports should be made. Apart from that,
flexible arrangements for the Department’s reporting to the legislature,
without restriction on content or timing of reports, would support the
maintenance of independence.
4.3.11 It is necessary that the Department of the AGP is provided with sufficient
resources, for the effective exercise of its mandate.
4.3.12 The executive branch of the government and the SAI do have common
interests in the promotion of public accountability. But the essential
relationship with the executive is that of external auditor. As such the
reports of the AGP are expected to assist the executive by drawing attention
to deficiencies in administration and recommending improvements. Care
should be taken to avoid participation in the executive’s functions of the
kind that would militate against the independence and objectivity of the
Department of the AGP in the discharge of its mandate.
4.3.13 It is important for the independence of the Department of the AGP that
there be no power of direction by the executive in relation to the
Department’s performance of its mandate. The Department shall not be
obliged to carry out, modify or refrain from carrying out, an audit or
suppress or modify audit findings, conclusions and recommendations.
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4.3.14 A degree of co-operation between the Department of the AGP and the
executive is desirable in some areas. The SAI shall be ready to advise the
executive in such matters as accounting standards and policies and the form
of financial statements. The Department must ensure that in giving such
advice it avoids any explicit or implied commitment that would impair the
independent exercise of its audit mandate.
4.3.15 Maintenance of the independence of the Department of the AGP does not
preclude requests by the executive proposing matters for audits. But to
enjoy adequate independence, the Department shall have the discretion to
decline any such request. It is fundamental to the concept of SAI
independence that decisions as to the audit tasks comprising the programme
shall rest finally with the Department of the AGP.
4.3.16 A sensitive area in relationships between the Department of the AGP and
the executive concerns provision of resources to the Department. In varying
degrees, reflecting constitutional and institutional differences, arrangements
for the SAI’s resource provision may be related to the executive branch of
government’s financial situation and general expenditure policies. As
against that, effective promotion of public accountability requires that the
Department of the AGP be provided with sufficient resources to enable it to
discharge its responsibilities in a reasonable manner.
4.3.17 Any imposition of resource or other restriction by the executive which
would constrain the exercise of its mandate by the Department of the AGP
would be an appropriate matter for report by the Department to the
legislature.
4.3.18 The legal mandate should provide for full and free access by the
Department of the AGP to all premises and records relevant to audited
entities and their operations and should provide adequate powers for the
Department to obtain relevant information from persons or entities
possessing it.
4.3.19 Unless specifically prevented by law, the executive shall permit access by
the Department of the AGP to sensitive information which is necessary and
relevant to the discharge of the responsibilities of the Department.
4.3.20 The Department of the AGP shall ensure that its mandate and its
independent status is well understood in the community. The Department
shall, as appropriate opportunities arise, undertake an educational role in
that regard.
4.3.21 Functional independence of the Department of the AGP need not preclude
arrangements with executive entities in regard to its administration in
matters such as personnel management, property management or common
purchasing of equipment and stores, though executive entities shall not be
in a position to take decisions that would jeopardise the independence of
the Department in discharging its mandate.
4.3.22 The Department of the AGP must remain independent from audited entities.
It shall, however, seek to create among audited entities an understanding of
its role and function, with a view to maintaining amicable relationships
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with them. Good relationships can help the department to obtain
information freely and frankly and to conduct discussions in an atmosphere
of mutual respect and understanding. In this spirit, the Department while
retaining its independence, can agree to be associated with reforms which
are planned by the Administration in areas such as public accounts or
financial legislation or agree to be consulted about the preparation of draft
laws or rules affecting its competence or its authority. In these cases it is
not, however, a matter of the Department interfering in administrative
management but a matter of co-operating with certain administrative
services by giving them technical assistance or by putting financial
management experience of the Department at their disposition.
4.3.23 In contrast to private sector audit, where the auditor’s agreed task is
specified in an engagement letter, the audited entity is not in a client
relationship with the Department of the AGP. The Department has to
discharge its mandate freely and impartially, taking management views into
consideration in forming audit opinions, conclusions and recommendations,
but owing no responsibility to the management of the audited entity for the
scope or nature of the audits undertaken.
4.3.24 The Department of the AGP shall not participate in the management or
operations of an audited entity. Audit personnel should not become
members of management committees and, if audit advice is to be given, it
shall be conveyed as audit advice or recommendation and acknowledged
clearly as such.
4.3.25 Any personnel of the Department of the AGP having close affiliations with
the management of an audited entity, such as social, kinship or other
relationship conducive to a lessening of objectivity, shall not be assigned to
audit that entity.
4.3.26 Personnel of the Department of the AGP should not become involved in
instructing personnel of an audited entity as to their duties. In those
instances where the Department decides to establish a resident office at the
audited entity with the purpose of facilitating the ongoing review of its
operations, programmes and activities, personnel of the Department of the
AGP shall not engage in any decision making or approval process which is
considered the auditee’s management responsibilities.
4.3.27 The Department of the AGP may co-operate with academic institutions and
enter formal relationships with professional bodies, provided the
relationships do not inhibit its independence and objectivity, in order to
avail itself of the advice of experienced members of the profession at large.
Conflict of interest
4.3.28 The Department of the AGP shall avoid conflict of interest between the
auditor and the entity under audit (see paragraph 4.3.1b)
4.3.29 The Department of the AGP performs its role by carrying out audits of the
accountable entities and reporting the results. To fulfil this role, the
Department needs to maintain its independence and objectivity. The
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application of appropriate general auditing standards assists the Department
to satisfy these requirements.
Competence
4.3.30 The general standards for the auditor and the Department of the AGP
include:
The auditor and the Department must possess the required competence (see
paragraph 4.3.1c)
The following paragraphs explain competence as an auditing standard.
4.3.31 The mandate of the Department of the AGP generally imposes a duty of
forming and reporting audit opinions, conclusions and recommendations.
This duty shall remain that of the heads of the Audit offices.
4.3.32 Discussions within the SAI promote the objectivity and authority of
opinions and decisions. Decision and opinions as such relating to
conclusions, findings and recommendations in the Audit reports are taken
in the name of the AGP.
4.3.33 Since the duties and responsibilities thus borne by the Department of the
AGP are crucial to the concept of public accountability, the Department
must apply to its audits, methodologies and practices of the highest quality.
It is incumbent upon it to formulate procedures to secure effective exercise
of its responsibilities for audit reports, unimpaired by less than full
adherence by personnel or external experts to its standards, planning
procedures methodologies and supervision.
4.3.34 The Department of the AGP needs to command the range of skills and
experience necessary for effective discharge of the audit mandate.
Whatever the nature of the audits to be undertaken under that mandate, the
audit work shall be carried out by persons whose education and experience
is commensurate with the nature, scope and complexities of the audit task.
The department shall equip itself with the full range of up-to-date audit
methodologies, including systems-based techniques, analytical review
methods, statistical sampling and audit of automated information systems.
4.3.35 In view of the wide and discretionary nature of mandate of the Department
of the AGP, the task of the ensuring quality of performance across the
whole mandate becomes more complex. The Department shall, therefore,
ensure, within itself, a high standard of management.
Due Care
4.3.36 The general standards for the auditor and the Department of the AGP
include
The auditor and the Department must exercise due care and concern in
complying with the auditing standards. This embraces due care in
specifying, gathering and evaluating evidence, and in reporting findings,
conclusions and recommendations (see paragraph 4.3.1d)
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The following paragraphs explain due care as an auditing standard.
4.3.37 The Department of the AGP must be, and be seen to be, objective in its
audit of entities and public enterprises. It should be fair in its evaluations
and in its reporting of the outcome of audits.
4.3.38 Performance and exercise of technical skill should be of a quality
appropriate to the complexities of a particular audit. Auditors need to be
alert for situations, control weaknesses, inadequacies in record keeping,
errors and unusual transactions or results which could be indicative of fraud,
improper or unlawful expenditure, unauthorised operations, waste,
inefficiency or lack of probity.
4.3.39 Where an authorised or recognised entity sets standards or guidelines for
accounting and reporting by public enterprises, the Department of the AGP
may use such guidelines in the course of its examination.
4.3.40 If the department of the AGP employs external experts as consultants it
must exercise due care to assure itself of the consultants’ competence and
aptitude for the particular tasks involved. This standard applies also where
outside auditors are engaged on contract with the Department. In addition
care must be taken to ensure that audit contracts include adequate provision
for the SAI to determine the planning, the audit scope, the performing, and
the reporting on the audit.
4.3.41 Should the Department of the AGP, in the performance of its functions,
need to seek advice from specialists external to the Department, the
standards for exercise of due care in such arrangements have a bearing also
on the maintenance of quality of performance. Obtaining advice from an
external expert does not relieve the Department of responsibility for the
opinions formed or conclusions reached on the audit task.
4.3.42 When the Department of the AGP uses the work of another auditor(s), it
must apply adequate procedures to provide assurance that the other
auditor(s) has exercised due care and complied with relevant auditing
standards, and may review the work of the other auditor(s) to satisfy itself
as to the quality of that work.
4.3.43 Information about an audited entity acquired in course of the auditor’s work
must not be used for purposes outside the scope of an audit and the
formation of an opinion or in reporting in accordance with the auditor’s
responsibilities. It is essential that the Department of the AGP maintain
confidentiality regarding audit matters and information arising from its
audit task. However, the Department must be entitled to report offences
against the law to proper prosecuting authorities.
4.4 Field Standards in Government Auditing
4.4.1 The purpose of field standards is to establish the criteria or overall
framework for the purposeful, systematic and balanced steps or actions that
the auditor has to follow. These steps and actions represent the rules of
research that the auditor, as a seeker of audit evidence, implements to
achieve a specific result.
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4.4.2 The field standards establish the framework for conducting and managing
audit work. They are related to the general auditing standards, which set out
the basic requirements for undertaking the tasks covered by the field
standards. They are also related to the reporting standards, which cover the
communication aspect of auditing, as the result of carrying out the field
standards constitute the main source for the contents of the opinion or
report.
4.4.3 The field standards applicable to all types of audit are:
a) The auditor shall plan the audit in a manner which ensures that an audit of
high quality is carried out in an economic, efficient and effective way and
in a timely manner (see paragraph 4.4.2.1)
b) The work of the audit staff at each level and audit phase shall be properly
supervised during the audit; and documented work shall be reviewed by a
senior member of the audit staff (see paragraph 4.4.3.1)
c) The auditor, in determining the extent and scope of the audit, shall study
and evaluate the reliability of internal control (see paragraph 4.4.4.1)
d) In conducting regularity (financial) audits, a test should be made of
compliance with applicable laws and regulations. The auditor should
design audit steps and procedures to provide reasonable assurance of
detecting errors, irregularities, and illegal acts that could have a direct and
material effect on the financial statement amounts or the results of
regularity audits. The auditor also should be aware of the possibility of
illegal acts that could have an indirect and material effect on the financial
statements or results of regularity audits.
4.4.4 In conducting performance audits, an assessment should be made of
compliance with applicable laws and regulations when necessary to satisfy
the audit objectives. The auditor should design the audit to provide
reasonable assurance of detecting illegal acts that could significantly affect
audit objectives. The auditor also should be alert to situations or
transactions that could be indicative of illegal acts that may have an indirect
effect on the audit results.
4.4.5 Any indications that an irregularity, illegal act, fraud or error may have
occurred which could have a material effect on the audit should cause the
auditor to extend procedures to confirm or dispel such suspicions.
4.4.6 The regularity audit is an essential aspect of government auditing. One
important objective which this type of audit assigns to the Department of
the AGP is to make sure, by all the means put at its disposal, that the
Government budget and accounts are complete and valid. This will provide
legislature and other users of the audit report with assurance about the size
and development of the financial obligations of the Government. To
achieve this objective the Department will examine the accounts and
financial statements of the administration with a view to assuring that all
operations have been correctly undertaken, completed, passed, paid and
registered. The audit procedure normally results, in the absence of
irregularity, in the granting of an unqualified certificate (see paragraph
4.4.5.1)
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e) Competent, reliable, relevant and reasonable evidence should be obtained
to
support the auditor’s judgment and conclusion regarding the organisation,
programme, activity or function under audit (see paragraph 4.4.6.1)
f) In regularity (financial) audit, and in other types of audit when applicable,
auditors should analyse the financial statements to establish whether
acceptable accounting standards for financial reporting and disclosure are
complied with. Analysis of financial statements should be performed to
such a degree that a rational basis is obtained to express an opinion on
financial statements (see paragraph 4.4.7.1)
Planning
4.4.7 The field standards include:
The auditor should plan the audit in a manner which ensures that an audit of
high quality is carried out in an economic, efficient and effective way and
in a timely manner (see paragraph 4.4.1.3a)
The following paragraphs explain planning as an auditing standard.
4.4.8 The Department of the AGP shall give priority to any audit tasks which
must be undertaken by law and assess priorities for discretionary areas
within mandate of the AGP.
4.4.9 In planning an audit, the auditor should:
a) Identify important aspects of the environment in which the audited
entity operates;
b) Develop an understanding of the accountability relationships;
c) Consider the form, content and users of audit opinions, conclusions or
reports;
d) Specify the audit objectives and the tests necessary to meet them;
e) Identify key management systems and controls and carry out a
preliminary assessment to identify both their strengths and weakness;
f) Determine the materiality of matters to be considered;
g) Review the internal audit of the audited entity and its work programme;
h) Assess the extent of the reliance that might be placed on other auditors,
for example, internal audit;
i) Determine the most efficient and effective audit approach;
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j) Provide for a review to determine whether appropriate action has been
taken on previously reported audit findings and recommendations; and
k) Provide for appropriate documentation of the audit plan and for the
proposed fieldwork.
4.4.10 The following planning steps are normally included in an audit;
a) Collect information about the audited entity and its organisation in
order to assess risk and to determine materiality;
b) Define the objective and scope of the audit;
c) Undertake preliminary analysis to determine the approach to be
adopted and the nature and extent of enquiries to be made later;
d) Highlight special problems foreseen when planning the audit;
e) Prepare a budget and a schedule for the audit;
f) Identify staff requirements and a team for the audit; and
g) Familiarise the audited entity about the scope, objectives and the
assessment criteria of the audit and discuss with them as necessary.
The SAI may revise the plan during the audit when necessary.
Supervision and Review
4.4.11 The field standards include:
The work of the audit staff at each level and audit phase should be properly
supervised during the audit, and documented work should be reviewed by a
senior member of the audit staff (see paragraph 4.4.1.3b)
The following paragraphs explain supervision and review as an auditing
standard.
4.4.12 Supervision is essential to ensure the fulfilment of audit objectives and the
maintenance of the quality of the audit work. Proper supervision and
control is therefore necessary in all cases, regardless of the competence of
the individual auditors.
4.4.13 Supervision should be directed both to the substance and to the method of
auditing. It involves ensuring that:
a) The members of the audit team have a clear and consistent understanding of
the audit plan;
b) The audit is carried out in accordance with the auditing standards and
practices of the Department of the AGP.
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c) The audit plan and action steps specified in that plan are followed unless a
variation is authorised;
d) Working papers contain evidence adequately supporting all conclusions,
recommendations and opinions;
e) The auditor achieves the stated audit objectives; and
f) The audit report includes the audit conclusions, recommendations and
opinions, as appropriate.
4.4.14 All audit work should be reviewed by a senior member of the audit staff
before the audit opinions or reports are finalised. It should be carried out as
each part of the audit progresses. Review brings more than one level of
experience and judgment to the audit task and should ensure that:
a) All evaluations and conclusions are soundly based and are supported by
competent, reliable, relevant and reasonable audit evidence as the
foundation for the final audit opinion or report;
b) all errors, deficiencies and unusual matters have been properly identified,
documented and either satisfactorily resolved or brought to the attention of
the more senior officer(s) of the department; and
c) changes and improvements necessary to the conduct of future audits are
identified, recorded and taken into account in later audit plans and in staff
development activities
4.4.1 Study and Evaluation of Internal Control
4.4.15 The field standards include
The auditor, in determining the extent and scope of the audit, should study
and evaluate the reliability of the internal control (see paragraph 4.4.1.3c)
The following paragraphs explain internal control as an auditing standard.
4.4.16 The study and evaluation of internal control should be carried out according
to the type of audit undertaken. In the case of a regularity (financial) audit,
study and evaluation are made mainly on controls that assist in
safeguarding assets and resources, and assure the accuracy and
completeness of accounting records. In the case of regularity (compliance)
audit, study and evaluation are made mainly on controls that assist
management in complying with laws and regulations. In the case of
performance audit, they are made on controls that assist in conducting the
business of the audited entity in an economic, efficient and effective
manner, ensuring adherence to management policies, and producing timely
and reliable financial and management information.
4.4.17 The extent of the study and evaluation of internal control depends on the
objectives of the audit and on the degree of reliance intended.
4.4.18 Where accounting or other information systems are computerised, the
auditor should determine whether internal controls are functioning properly
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to ensure the integrity, reliability and completeness of the data, and the
information system.
Compliance with Applicable Laws and Regulations
4.4.19 The field standards include:
In conducting regularity (financial) audits, a test should be made of compliance
with applicable laws and regulations. The auditor should design audit steps and
procedures to provide reasonable assurance of detecting errors, irregularities, and
illegal acts that could have a direct and material effect on the financial statement
amounts or the results of regularity audits. The auditor also should be aware of the
possibility of illegal acts that could have an indirect and material effect on the
financial statements or results of regularity audits.
In conducting performance audits, an assessment should be made of compliance
with applicable laws and regulations when necessary to satisfy the audit objectives.
The auditor should design the audit to provide reasonable assurance of detecting
illegal acts that could significantly affect audit objectives. The auditor should also
be alert to situations or transactions that could be indicative of illegal acts that may
have an indirect effect on audit results.
The regularity audit is an essential aspect of government auditing. One important
objective which this type of audit assigns to the Department of the AGP is to make
sure, by all the means put at its disposal, that the Government budget and accounts
are complete and valid. This will provide legislatures and other users of the audit
report with assurance about the size and development of the financial obligations of
the Government. To achieve this objective the Department will examine the
accounts and financial statements of the administration with a view to assuring that
all operations have been correctly undertaken, completed, passed, paid and
registered. The audit procedure normally results, in the absence of irregularity, in
the granting of an unqualified certificate (see paragraph 4.4.1.3d)
The following paragraphs explain compliance as an auditing standard.
4.4.20 Reviewing compliance with laws and regulations is especially important
when auditing government programmes because decision makers need to
know if the laws and regulations are being followed, whether they are
having the desired results, and, if not, what revisions are necessary.
Additionally government organisation, programmes, services, activities,
and functions are created by laws and are subject to more specific rules and
regulations.
4.4.21 Those planning the audit need to be knowledgeable of the compliance
requirements that apply to the entity being audited. Because the laws and
regulations that may apply to a specific audit are often numerous, the
auditors need to exercise professional judgment in determining those laws
and regulations that might have a significant impact on the audit objectives.
4.4.22 The auditor should also be alert to situations or transactions that could be
indicative of illegal acts that may indirectly impact the results of the audit.
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When audit steps and procedures indicate that illegal acts have or may have
occurred, the auditor shall determine the extent to which these acts affect
the audit results.
4.4.23 In conducting audits in accordance with this standard, the auditors should
choose and perform audit steps and procedures that, in their professional
judgment, are appropriate in the circumstances. These audit steps and
procedures should be designed to obtain sufficient, competent, reliable, and
relevant evidence that will provide a reasonable basis for their judgments
and conclusions.
4.4.24 Generally, management is responsible for establishing an effective system
of internal controls to ensure compliance with laws and regulations. In
designing steps and procedures to test or assess compliance, auditors should
evaluate the entity’s internal controls and assess the risk that the control
structure might not prevent or detect non-compliance.
4.4.25 Without affecting the independence of the Department of the AGP, the
auditors should exercise due professional care and caution in extending
audit steps and procedures relative to illegal acts so as not to interfere with
potential future investigations or legal proceedings. Due care would include
consulting appropriate legal counsel and the applicable law enforcement
organisation/agencies to determine the audit steps and procedures to be
followed.
Audit Evidence
4.4.26 The field standards include
Competent, reliable, relevant and reasonable evidence should be obtained to
support the auditor’s judgment and conclusions regarding the organisation,
programme, activity or function under audit (see paragraph 4.4.1.3e)
The following paragraphs explain the audit evidence as an auditing standard.
4.4.27 The audit findings, conclusions and recommendations must be based on
evidence. Since auditors seldom have the opportunity of considering all
information about the audited entity, it is crucial that the data collection and
sampling techniques are carefully chosen. When computer-based system
data are an important part of the audit and the data reliability is crucial to
accomplishing the audit objective, auditors need to satisfy themselves that
the data are reliable and relevant.
4.4.28 Auditors should have a sound understanding of techniques and procedures
such as inspection, observation, enquiry and confirmation, to collect audit
evidence. The Department of the AGP shall ensure that the techniques
employed are sufficient to reasonably detect all quantitatively material
errors and irregularities.
4.4.29 In choosing approaches and procedures, consideration should be given to
the quality of evidence, i.e., the evidence should be competent, reliable,
relevant and reasonable.
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4.4.30 Auditors should adequately document the audit evidence in working papers,
including the basis and extent of the planning, work performed and the
findings of the audit.
4.4.31 Adequate documentation is important for several reasons. It will:
a) Confirm and support the auditor’s opinions and reports;
b) Increase the efficiency and effectiveness of the audit;
c) Serve as a source of information for preparing reports or answering any
enquiries from the audited entity, legislature and its committees or
from any other party;
d) Serve as evidence of the auditor’s compliance with Auditing Standards;
e) Facilitate planning and supervision;
f) Help the auditor’s professional development;
g) Help to ensure that delegated work has been satisfactorily performed;
and
h) Provide evidence of work done for future reference.
4.4.32 The auditor should bear in mind that the content and arrangement of the
working papers reflect the degree of the auditor’s proficiency, experience
and knowledge. Working papers should be sufficiently complete and
detailed to enable an experienced auditor having no previous connection
with the audit subsequently to ascertain from them what work was
performed to support the conclusions.
Analysis of Financial Statements
4.4.33 The field standards include:
In regularity (financial) audit, and in other types of audit when applicable,
auditors should analyse the financial statements to establish whether
acceptable accounting standards for financial reporting and disclosure are
complied with. Analysis of financial statements shall be performed to such
a degree that a rational basis is obtained to express an opinion on financial
statements (see paragraph 4.4.1.3f)
The following paragraphs explain analysis of financial statements as an
auditing standard.
4.4.34 Financial statement analysis aims at ascertaining the existence of the
expected relationship within and between the various elements of the
financial statements, identifying any unexpected relationships and any
unusual trends. The auditor should therefore thoroughly analyse the
financial statements and ascertain whether:
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a) Financial statements are prepared in accordance with acceptable
accounting standards;
b) Financial statements are presented with due consideration to the
circumstances of the audited entity;
c) Sufficient disclosures are presented about various elements of financial
statements; and
d) The various elements of financial statements are properly evaluated,
measured and presented.
4.4.35 The methods and techniques of financial analysis depend to a large degree
on the nature, scope and objective of the audit, and on the knowledge and
judgment of the auditor.
4.4.36 If required to report on the execution of budgetary laws, audit by the
Department of the AGP shall include:
a) For revenue accounts, ascertaining whether forecasts are those of the
initial budget, and whether the audits of taxes and duties recorded, and
imputed receipts, can be carried out by comparison with the annual
financial statements of the audited activity;
b) For expenditure accounts, verifying credits to assist budgets, adjustment
laws and, for carryovers, the previous year’s financial statements.
4.5 Reporting Standards in Government Auditing
4.5.1 It is not practical to lay down a rule for reporting on every special situation.
This standard is to assist and not to supersede the prudent judgment of the
auditor in making an opinion or report.
4.5.2 The expression “reporting” embraces both the auditor’s opinion and other
remarks on a set of financial statements as a result of a regularity (financial)
audit and the auditor’s report on completion of a performance audit.
4.5.3 The auditor’s opinion on a set of financial statements shall generally be in
concise, standardised format to reflect the results of a wide range of tests
and other audit work. There is a requirement to report as to the compliance
of transactions with laws and regulations and to report on matters such as
inadequate systems of control, illegal acts and fraud. The constitutional or
statutory obligations require the AGP to report specifically on the execution
of budgetary laws, reconciling budgetary estimates and authorisation to the
results set out in the financial statements.
4.5.4 In a performance audit, the auditor reports on the economy and efficiency
with which resources are required and used, and the effectiveness with
which objectives are met. Such reports may vary considerably in scope and
nature, for example, covering whether resources have been applied in a
sound manner, commenting on the impact of policies and programmes and
recommending changes designed to result in improvements.
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4.5.5 In order to recognise reasonable user needs, the auditor’s report in both
regularity and performance auditing may need to have regard to expanded
reporting periods or cycles and relevant and appropriate disclosure
requirements.
4.5.6 For ease of reference in this chapter, the word “opinion” is used to mean the
auditor’s conclusions as a result of a regularity (financial) audit, and may
embrace the matters described in paragraph 4.4.3; the word “report” is used
to mean the auditor’s conclusions following a performance audit, as
described in paragraph 4.4.4
4.5.7 The reporting standards are:
a) At the end of each audit the auditor shall prepare a written opinion or report,
as appropriate, setting out the findings in an appropriate form; its content
should be easy to understand and free from vagueness or ambiguity, include
only information which is supported by competent, reliable, and relevant
audit evidence, and be independent, objective, fair and constructive.
b) It is for the Department of the AGP to decide finally on the action to be
taken in relation to fraudulent practices or serious irregularities discovered
by the auditors.
With regards to regularity audits, the auditor shall prepare a written report,
which may either be a part of the report on the financial statements or a
separate report, on the test of compliance with applicable laws and
regulations. The report shall contain a statement of positive assurance on
those tested for compliance and negative assurance on those items not
tested.
With regard to performance audits, the report shall include all significant
instances of non-compliance that are pertinent to the audit objectives.
The following paragraphs explain reporting as an auditing standard.
Paragraph 4.4.8 relates both to opinions and reports, paragraphs 4.4.9 –
4.4.19 relate to opinions and paragraphs 4.4.20 – 4.4.25 to reports.
4.5.8 The form and content of all audit opinions and reports are founded on the
following general principles.
a)
Title. The opinion or report shall be preceded by a suitable title or
heading, helping the reader to distinguish it from statements and
information issued by others.
b)
Signature and date. The opinion or reports shall be properly signed.
The inclusion of a date informs the reader that consideration has been
given to the effect of events or transactions about which the auditor
became aware up to that date (which, in the case of regularity (financial)
audits, may be beyond the period of the financial statements).
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Audit Manual – Chapter 4
c)
Objectives and scope. The opinion or report shall include reference to
the objectives and scope of the audit. This information establishes the
purpose and boundaries of the audit.
d)
Completeness. Opinions shall be appended to and published with the
financial statements to which they relate, but performance reports may
be free standing. The auditor’s opinions and reports shall be presented
as prepared by the auditor. In exercising its independence the
Department shall be able to include whatever it sees fit, but it may
acquire information from time to time which in the national interest
cannot be freely disclosed. This can affect the completeness of the audit
report. In this situation the auditor retains a responsibility for
considering the need to make a report, possibly including confidential
or sensitive material in a separate, unpublished report.
e)
Addressee. The opinion or report shall be addressed as per
requirements of applicable laws and procedures.
f)
Identification of subject matter. The opinion or report shall identify
the financial statements (in the case of regularity (financial) audits) or
area (in the case of performance audits) to which it relates. This
includes information such as the name of the audited entity, the date
and period covered by the financial statements and the subject matter
that has been audited.
g)
Legal basis. Audited opinions and reports shall identify the legislation
or other authority providing for the audit.
h)
Compliance with standards: Audit opinions and reports shall indicate
the auditing standards or practices followed in conducting the audits,
thus providing the reader with an assurance the audit has been carried
out in accordance with generally accepted procedures.
i)
Timelines: The audit opinion or report shall be available promptly to be
of greatest use to readers and users, particularly those who have to take
necessary action.
4.5.9 An audit opinion is normally in a standard format, relating to the financial
statements as a whole, thus avoiding the need to state at length what lies
behind it but conveying by its nature a general understanding among
readers as to its meaning. The nature of these words will be influenced by
the legal framework for the audit, but the content of the opinion shall
indicate unambiguously whether it is unqualified or qualified and, if the
latter, whether it is qualified in certain respects or is adverse (paragraph
4.4.14) or a disclaimer (paragraph 4.4.15) of opinion.
4.5.10 An unqualified opinion is given when the auditor is satisfied in all material
respects that:
a) The financial statements have been prepared using acceptable accounting
bases and policies which have been consistently applied;
Audit Manual – Chapter 4
4-27
b) The statements comply with statutory requirements and relevant regulations;
c) The view presented by the financial statements is consistent with the
auditor’s knowledge of the audited entity; and
d) There is adequate disclosure of all material matters relevant to the financial
statements
4.5.11
Emphasis of Matter. In certain circumstances the auditor may consider
that the reader will not obtain a proper understanding of the financial
statements unless attention is drawn to unusual or important matters. As a
general principle the auditor issuing an unqualified opinion does not make
reference to specific aspects of financial statements in the opinion in case
this should be misconstrued as being a qualification. In order to avoid
giving that impression, references which are meant as “emphasis of matter”
are contained in a separate paragraph from the opinion. However, the
auditor shall not make use of an emphasis of matter to rectify a lack of
appropriate disclosure in the financial statements, nor as an alternative to,
or a substitute for, qualifying the opinion.
4.5.12 An auditor may not be able to express an unqualified opinion when any of
the following circumstances exist and, in the auditor’s judgment, their
effect is or may be material to the financial statements:
a) There has been limitation on the scope of the audit:
b) The auditor considers that the statements are incomplete or misleading or
there is an unjustified departure from acceptable accounting standards; or
c) There is uncertainty affecting the financial statements.
4.5.13
Qualified Opinion. Where the auditor disagrees with or is uncertain about
one or more particular items in the financial statements which are material
but not fundamental to an understanding of the statements, a qualified
opinion should be given. The wording of the opinion normally indicates a
satisfactory outcome to the audit subject to a clear and concise statement of
the matters of disagreement or uncertainty giving rise to the qualified
opinion. It helps the users of the statements if the financial effect of the
uncertainty or disagreement is quantified by the auditor although this is not
always practicable or relevant.
4.5.14
Adverse Opinion. Where the auditor is unable to form an opinion on the
financial statements taken as a whole due to disagreement which is so
fundamental that it undermines the position presented to the extent that an
opinion which is qualified in certain respects would not be adequate, an
adverse opinion is given. The wording of such an opinion makes clear that
the financial statements are not fairly stated, specifying clearly and
concisely all the matters of disagreement. Again, it is helpful if the financial
effect on the financial statements is quantified where relevant and
practicable.
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Audit Manual – Chapter 4
4.5.15
Disclaimer of Opinion. Where the auditor is unable to arrive at an opinion
regarding the financial statements taken as a whole due to an uncertainty or
scope restriction which is so fundamental that an opinion which is qualified
in certain respects would not be adequate, a disclaimer is given. The
wording of such a disclaimer makes clear that an opinion cannot be given,
specifying clearly and concisely all matters of uncertainty.
4.5.16 The auditor shall provide a detailed report amplifying the opinion in
circumstances in which it has been unable to give an unqualified opinion.
4.5.17 In addition, regularity audits often require that reports are made where
weaknesses exist in systems of financial control or accounting (as distinct
from performance audit aspects). This may occur not only where
weaknesses affect the audited entity’s own procedures but also where they
relate to its control over the activities of others. The auditor shall also report
on significant irregularities, whether perceived or potential, on
inconsistency of application of regulations or on fraud and corrupt practices.
4.5.18 In reporting on irregularities or instances of non-compliance with laws or
regulations, the auditors should be careful to place their findings in the
proper perspective. The extent of non-compliance can be related to the
number of cases examined or quantified monetarily.
4.5.19 Reports on irregularities shall be prepared irrespective of a qualification of
the auditor’s opinion. By their nature they tend to contain significant
criticisms, but in order to be constructive they shall also address future
remedial action by incorporating statements by the audited entity or by the
auditor, including conclusions or recommendations.
4.5.20 In contrast to regularity audit, which is subject to fairly specific
requirements and expectations, performance audit is wide-ranging in nature
and is more open to judgment and interpretation; coverage is also more
selective and may be carried out over a cycle of several years, rather than in
one financial period; and it does not normally relate to particular financial
or other statements. As a consequence performance audit reports are varied
and contain more decisions and reasoned argument.
4.5.21 The performance audit report should state clearly the objectives and scope
of the audit. Reports may include criticism (for example where, in the
public interest or on grounds of public accountability, matters of serious
waste, extravagance or inefficiency are drawn to attention) or may make no
significant criticism but give independent information, advice or assurance
as to whether and to what extent economy, efficiency and effectiveness are
being or have been achieved.
4.5.22 The auditor is not normally expected to provide an overall opinion on the
achievement of economy, efficiency and effectiveness by an audited entity
in the same way as the opinion on financial statements. Where the nature of
the audit allows this to be done in relation to specific areas of entity’s
activities, the auditor shall provide a report which describes the
circumstances and arrives at a specific conclusion rather than a standardised
statement. Where the audit is confined to consideration of whether
Audit Manual – Chapter 4
4-29
sufficient controls exist to secure economy, efficiency or effectiveness, the
auditor shall provide a more general opinion.
4.5.23 Auditors should recognise that their judgments are being applied to actions
resulting from past management decisions. Care should therefore be
exercised in making such judgment s, and the report should indicate the
nature and extent of information reasonably available (or which ought to
have been available) to the audited entity at the time the decisions were
taken. By stating clearly the scope, objectives and findings of the audit, the
report demonstrates to the reader that the auditor is being fair. Fairness also
implies the presentation of weaknesses or critical findings in such a way as
to encourage correction, and to improve systems and guidance within the
audited entity. Accordingly the facts are generally agreed with the audited
entity in order to ensure that they are complete, accurate and fairly
presented in the audit report. There may also be a need to include the
audited entity’s responses to the matters raised, either verbatim or in
summary, especially where the Department of the AGP presents its own
views or recommendations.
4.5.24 Performance reports should not concentrate solely on criticism of the past
but should be constructive. The auditor’s conclusion and recommendations
are an important aspect of the audit and, where appropriate, are written as a
guide for action. Generally these recommendations suggest what
improvements are needed rather than how to achieve them, though
circumstances sometimes arise which warrant a specific recommendation,
for example to correct a defect in the law in order to bring about an
administrative improvement.
4.5.25 In formulating and following up recommendations, the auditor shall
maintain objectivity and independence and thus focus on whether identified
weaknesses are corrected rather than on whether specific recommendations
are adopted.
4.5.26 In formulating the audit opinion or report, the auditor shall have regard to
the materiality of the matter in the context of the financial statements
(regularity (financial) audit) or the nature of the audited entity or activity
(performance audit).
4.5.27 For regularity (financial) audits, if the auditor concludes that, judged
against the criteria most appropriate in the circumstances, the matter does
not materially affect the view given by the financial statements, the opinion
should not be qualified. Where the auditor decides that a matter is material
the opinion should be qualified, having determined the type of qualification
(paragraphs 4.4.12 – 4.4.15)
4.5.28 In the case of performance audits that judgment will be more subjective as
the report does not relate so directly to financial or other statements.
Consequently the auditor may find materiality by nature or by context is a
more important consideration than materiality by amount.
Audit Manual – Chapter 5
5-1
5. DAGP’S ANNUAL PLANNING PROCESS
5.1 DAGP Strategic Audit Objectives
5.1.1 The Auditor-General’s mandate is established by legislation – Auditor-
General’s (Functions, Powers and Terms and Conditions of Service)
Ordinance, 2001 (Auditor General’s Ordinance). Two key sections are:
5.1.2 Section 7 of Auditor-General’s (Functions, Powers and Terms and
Conditions of Service) Ordinance, 2001 (Auditor General’s Ordinance)
states that “The Auditor-General shall, on the basis of such audit as he may
consider appropriate and necessary, certify the accounts” … “of the
Federation, of each Province and of each District”.
5.1.3 Section 8 of the Auditor-General Ordinance mandates an audit of
expenditures of the Federation and of each Province, and Section 12 of the
Auditor-General Ordinance mandates an audit of the receipts of the Federal
Government and of each Province and District.
5.1.4 These sections establish the two primary objectives of DAGP audits:
financial attest/certification audits and compliance with authority audits to
ensure entities within all three levels of government properly comply with
all rules and regulations pertaining to expenses and revenues.
5.1.5 Note that all attest/certification audits will include a compliance component
in accordance with international auditing standards and that DAGP may
also perform independent compliance with authority audits in any areas
which the Auditor-General considers it important to review. Accordingly
compliance audit activities will be a major aspect of DAGP plans for any
given time period.
5.2 DAGP Audit Scope
5.2.1 In determining the scope of audit work the Auditor-General has wide
discretion.
5.2.2 For attest/certification audits required under Section 7 of the Auditor-
General Ordinance, the entity to be audited will be defined by the
applicable accounting policies of the government. For example, to certify
the financial statements of the Federation, the entity to be audited is the
aggregate of all of the ministries, departments, agencies, etc. that the
accounting policies require to be included in the financial statements of the
Federation. Whether to perform audit activities in every single entity
within the federation is a matter for the Auditor-General to decide. At a
minimum, audit activities should cover all entities whose operations are
material in the context of the financial statements of the Federation. In
addition, the Auditor-General may plan to extend the audit activities to any
other entities he considers significant.
5.2.3 In the case of compliance with authority audits, the Auditor-General has
complete discretion as to which entities (whether organisational entities,
Whether to perform
audit activities in
every single entity
within the
federation is a
matter for the
Auditor-General to
decide
Audit acitivities
should cover all
entities whose
operations are
material.
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Audit Manual – Chapter 5
such as agencies, DAOs, DDOs etc., functional entities, such as the payroll
function or the purchasing function; or accounting entities, such as objects
of expenditure, grants or appropriations) will be subject to audit and how
often audits will be conducted.
5.3 DAGP Strategic Audit Plans
5.3.1 The Auditor-General is responsible for deciding what audit work is
necessary to fulfil his mandate. Under his direction, DAGP produces a
multi-year strategic plan for DAGP audit activities. The audits included in
the strategic plan will include:
5.3.2
Mandatory and centrally led. These are audits required by DAGP’s
mandate to be performed each year, where the work performed by an
individual directorate is part of a larger audit. An example of such an audit
is the annual audit of the financial statements of the Federation.
5.3.3
Not mandatory and centrally led. These are audits where DAGP’s mandate
does not require that they be performed each year, and the work performed
by the directorate is part of a larger audit exercise. An example of this type
of audit could be a government-wide audit of contracting.
5.3.4
Mandatory and not centrally led. Those audits that are required by DAGP’s
mandate to be performed each year, where the work is not part of a larger
audit. An example of such an audit is the annual audit of the financial
statements of a specific commercial entity or a foreign-aided project for
which the directorate is required to issue an audit opinion.
5.3.5 In these cases, the Auditor-General schedules the activities and delegates
audit work to the audit directorates.
5.3.6 Consolidating the plans for all these audits produces the DAGP strategic
audit programme.
5.4 The annual planning process
5.4.1 Each audit directorate is responsible for the audit of a pre-determined group
of entities. The scheduling of this work is at the discretion of the audit
directorates:
5.4.2
Not mandatory and not centrally led. These are audits that are not required
by DAGP’s mandate to be performed each year, and which are not part of a
larger audit. An example of such an audit is the compliance with authority
work being performed by the directorate on the entities for which it is
responsible.
.
5.4.3 Each directorate prepares an annual audit plan for its audit activities which
includes the audit activities required by the Auditor-General, plus the
discretionary audits planned by the directorate, and submits it to the
Auditor-General for approval. Once approved, the annual plans from all
directorates are consolidated into DAGP’s annual Corporate Audit Plan.
Audit Manual – Chapter 5
5-3
5.4.4 The annual audit plans contain:
a) A summary of the directorate’s mandate.
b) A status report on the current year indicating the extent to which the
planned coverage for the current year is being achieved.
c) A summary of the audits that the directorate intends to perform in the
following year, categorised by:
•
Financial audits (including related compliance with authority audit);
•
Compliance with authority audits (where additional compliance with
authority work is planned);
•
Audits of internal controls;
•
Audits of foreign-aided projects;
•
Performance audits;
•
Other functional, systems, programme and fraud audits; and
•
Special assignments.
d) Details with respect to each of the planned audits for the following year.
These details include, for each audit:
•
The revenue and expenditure to be audited;
•
The person days required;
•
The staff members to be assigned to the audit (and any shortfall in the
staffing);
•
The travel and daily allowances that are required;
•
A time schedule showing the dates by which each audit will be planned,
executed, reported, etc.
e) A summary of the unallocated resources available within the directorate or
the audit work for which staff is not available.
5.4.5 Audit management software is useful for developing this plan.
5.4.6 With respect to centrally led audits, each directorate will estimate the
number of hours required to perform the work, the staff to be assigned to
the work, and the timing of the work, and provide this information to the
responsible central team. The central team, in turn, will be responsible for
the overall budget of the audit.
5.4.7 This process is discussed further in Section 5.6 below.
5.4.8 As noted, some audits are not required each year. This provides the audit
teams with some flexibility in scheduling work, so work loads can be
balanced to reflect the number of resources available after taking into
account resource assignments to mandatory audit work.
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Audit Manual – Chapter 5
5.4.9 For example, the nature, extent and timing of the work that DAGP performs
on its compliance with authority audits is somewhat discretionary. DAGP
auditors can decide to perform extensive tests of compliance with
authorities or more limited tests. As such, the budget for a given
compliance with authority audit can be increased or decreased as required
to match the available resources.
5.4.10 When deciding on the nature, extent and timing of the work that each
directorate performs on compliance with authority audits, audits of internal
controls and performance audits, the directorate should take into
consideration the annually required work that it is performing, and integrate
the audits to the extent possible. This is discussed in more detail in below.
5.4.11 Each directorate should ensure that it has sufficient staff with necessary
skills to accomplish the work required by the Auditor-General Ordinance to
be performed each year. Only plans for the work that is not required to be
performed each year may reflect staff shortfalls.
5.4.12 Where staffing shortages are evident, senior management within DAGP
will attempt to match one directorate’s staff shortfall with unallocated staff
in another directorate. Overall, though, the planned workload cannot exceed
the available resources. Should the sum of the required resources exceed the
available resources, the discretionary audit work must be decreased.
5.5 Integration of Audit Work
5.5.1 Under DAGP’s annual planning approach, each directorate has discretion
over work that is not required by the Auditor-General Ordinance to be
performed annually. The directorate can decide, for example, which entities
it wishes to audit, and the types of audits it wishes to perform (compliance
with authority, internal controls, performance, etc.). However, to improve
the efficiency and effectiveness of the work, DAGP recommends that each
directorate integrate its compliance with authority, internal control and
performance audit work that is not required to be performed each year with
the work being performed on the mandated annual audits, such as the
annual audits of financial statements. This integration could include:
a) Performing the work at the same time; and
b) Re-using the sample items selected for the financial audit work when
performing the compliance with authority, internal controls and
performance audit work. (Additional items could be selected if
considered necessary.)
5.5.2 Synchronising the timing of compliance with authority work and other
discretionary work to better match the timing of financial audit work,
would create the following benefits:
a) Samples for financial audit and compliance with authority purposes
could be integrated, reducing the total amount of audit work being
performed.
b) When doing the financial audit work, the auditors could rely on the
normally larger amount of work done for compliance with authority
Audit Manual – Chapter 5
5-5
purposes. When the compliance with authority audit work is done
several years later, this reliance is not possible.
c) With auditors performing compliance with authority audit work on
Year 1 transactions in Year 4, there is a risk that the auditors could
discover, in Year 4, significant errors with respect to the accounts for
Year 1. DAGP could then be in the embarrassing position of having to
amend and reissue its certificate on the Year 1 financial statements.
Doing all of the work in Year 1 would eliminate this problem.
5.5.3 In addition to these benefits, doing the compliance with authority work
more frequently, and covering fewer years during each audit, could benefit
the compliance with authority work itself, as follows:
a) There would be more timely identification of deficiencies, which could
lead to a quicker improvement of the related controls. This, in turn,
should significantly reduce compliance with authority violations in
subsequent years;
b) Having auditors on the premises provides a deterrence factor – entity
officials are less likely to commit frauds or perform sloppy work when
auditors are present. More frequent visits will multiply this effect.
c) Entity officials would no longer be required to find vouchers and other
documents that are several years old. This could make it easier for them
to find the required documents.
5.5.4 There are some disadvantages to amending the rotational audit approach for
compliance with authorities. The most significant one is that auditors will
spend less time at each location during each visit. This could increase the
coordination effort, travel time, start-up time, etc.
5.5.5 Because of these disadvantages, and because directorates may have other
very valid reasons for not following the recommended approach, that
DAGP has chosen not to mandate any one approach. However, directorates
not following the recommended approach may be asked to justify the
reasons for not doing so.
5.6 Approval Process for the Budget Of Centrally-Led
Audits
5.6.1 As noted above, the first two categories of audits are centrally led. Each
directorate will need to discuss the number of hours required to perform the
work, the staff to be assigned to the work, and the timing of the work, with
the responsible central team. The central team, in turn, will be responsible
for the overall budget of the audit.
5.6.2 One of the responsibilities of the central team is to set the budget (both
person days and costs) and the deadline dates for this audit. To do so, the
central team will adhere to the following process:
a) first estimate the number of hours and costs required to perform the
audit, and the approximate timing of the work;
5-6
Audit Manual – Chapter 5
b) then allocate the estimated hours of work to the central team, and each
audit directorate;
c) meet with each directorate to ensure that the directorate can perform the
work within the proposed budgets and by the required deadline dates.
Obtain the list of staff members from the audit directorate who will
perform the work, and the proposed scheduling for each of those staff
members;
d) following the discussions with each directorate, update the budget for
each directorate, and the overall budget for the audit;
e) obtain the approval of the Auditor General for this budget; and
f) once the central team has received the required approval, each
directorate will set aside the agreed-upon person days, dates, and staff
members for the performance of the audit.
Audit Manual – Chapter 6
6-1
6. THE AUDIT CYCLE
6.1 Introduction
6.1.1 Every audit assignment must be properly planned. The auditor has a
professional duty to undertake each audit in a manner that ensures reliable
and meaningful conclusions, which in turn lead to practical and useful audit
recommendations. The auditor must therefore collect appropriate and
sufficient evidence to arrive at such conclusions and recommendations. The
efficient and effective collection of evidence depends on a clear audit plan.
This audit plan should include a well-developed audit programme.
6.1.2 The audit plan should include:
a) A clear statement of the audit objective(s);
b) Statement of the magnitude of operations (expenditures, revenues,
assets, personnel) and for an attest audit, the significant line items and
accounts in the financial statements and significant financial statement
assertions;
c) Summary of significant issues and results of an initial risk assessment;
d) Proposed audit scope, including:
-
Type(s) of audit activity (attest, compliance, effectiveness of internal
controls, safeguarding of assets, fraud investigation, value-for-money,
IT systems, or some combination thereof);
-
locations to be visited;
-
functions, activities, systems and procedures to be examined;
-
aspects of performance to be covered;
-
audit methods and tests; and
-
samples selected or methods of selecting samples.
e) Budget and schedule;
f) Audit steps; and
g) Assigned audit responsibilities.
6.1.3 DAGP audit teams should plan to perform audits that encompass both
financial attest and compliance components. These two audit components
have much in common. Each requires the auditor to:
a) Understand the audit entity;
b) Conduct a risk assessment;
c) Define audit objectives and scope;
d) Develop an audit programme
e) Test the controls;
f) Determine sample size (for statistical or non-statistical);
g) Conduct substantive tests;
h) Report; and
i) Follow up.
Efficient and
effective collection
of evidence depends
on a clear audit plan
DAGP audit teams
should plan audits that
encompass both financial
attest and compliance
components.
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Audit Manual – Chapter 6
6.1.4 The audit cycle for an individual audit involves planning the audit,
conducting the work, evaluating the results of the work, reporting the
results of the work, and following up to see what the entity has done as a
result of the work. (Sometimes the follow up is conducted as the first phase
of the next audit of the entity, where the auditor determines what changes
have occurred since the previous audit).
6.1.5 This Chapter describes the audit cycle for an individual audit performed in
accordance with DAGP’s auditing standards. This Chapter also summarises
the work that is performed at each phase of the cycle. This material is
expanded upon in subsequent Chapters of this Manual.
6.1.6 The audit cycle is shown in Figure 6.1. It contains six basic phases:
a) General audit planning;
b) Detailed activity and resource planning;
c) Fieldwork;
d) Evaluation;
e) Reporting; and
f) Follow-up.
6.1.7 These phases are discussed in more detail below.
6.1.8 Because many financial statement audits are performed every year, much of
the general and detailed planning for these audit activities will be limited to
updating the planning decisions made in the previous year to reflect
changes to the entity or desired changes to the audit approach. There will
rarely be a need to start from scratch.
6.1.9 Changes to the audit approach will normally have been identified at the end
of the previous year’s audit. The auditors will have identified significant
issues that need to be revisited in the next audit, as well as areas requiring
less audit effort, such as where the internal controls were found to be
strong, allowing more reliance to be placed upon them. At that time, the
auditors would have assessed the overall efficiency and effectiveness of
their audit, and identified possible ways in which the efficiency and
effectiveness could be improved. This process could include analysing the
feedback obtained from entity officials, the PAC, and the media.
6.1.10 Audit management (providing advice, supervising, reviewing, approving,
etc.) is not listed as a separate step in the audit cycle. This is because these
activities need to occur throughout each phase of the process.
6.1.11 Creating good relations with entity officials is key to achieving an effective
and efficient audit. The progress and outcomes of an audit will be enhanced
if the audit team can obtain the cooperation of management and foster
confidence by maintaining a fully professional approach during the course
of the audit.
Audit Manual – Chapter 6
6-3
6.1.12 It is important for the auditor to avoid creating an adversarial relationship
with entity officials. To facilitate good relations the auditor should:
a) Be fully aware of all other audit activities being undertaken;
b) Plan to minimise impact on the audit entity; and
c) Ensure that all discussions with entity officials take place at an appropriate
and reasonable level, and at an appropriate and reasonable time.
Figure 6.1: Audit Cycle for Individual Audits
Understand the entity's business
Establish audit objectives and scopes
Assess materiality, planned precision,
and audit risk
Understand the entity's internal control structure
Determine components
Determine financial audit and compliance with authority objectives and
error/irregularity conditions
Assess inherent and control risk
Develop audit programmes
Execute audit programmes
Conclude on results of work
Issue reports
A
UDIT
PLA
NNING
Determine mix of tests of internal control, analytical procedures and
substantive tests of details
ACTIVITY AND
RESOURCE
PLANNING
FIELDWORK
EVALUATION
REPORTING
FOLLOW UP
Follow up matters in reports
Establish resource requirements and timing
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Audit Manual – Chapter 6
6.2 General audit planning
6.2.1 The general audit planning phase is where most key planning decisions are
made. It involves:
Step 1 Establish audit objectives and scope;
Step 2 Understand the entity’s business;
Step 3 Assess materiality, planned precision and audit risk;
Step 4 Understand the entity’s internal control structure;
Step 5 Determine components;
Step 6 Determine financial audit and compliance with authority objectives, and
error/irregularity conditions;
Step 7 Assessment inherent risk and control risk; and
Step 8 Determine mix of tests of internal control, analytical procedures and
substantive tests of details.
6.2.2 These steps are introduced below, and are discussed in more detail in the
next Chapter.
Step 1 – Establish overall audit objectives and scope
6.2.3 The audit objective should be a clear statement of what the auditor intends
to examine and what is to be achieved by the audit. There should be clear
audit objectives for every assertion, for each financial statement component
and for each audit area to be examined.
6.2.4 One or more audit objectives should be defined for each component of a
financial audit and for each line of inquiry. The audit objective is a
statement of what is to be achieved by the audit.
6.2.5 The audit scope is a statement of what areas will be looked at, what work
must be done and what will not be done and the methodology to be used to
achieve the audit objectives(s).
6.2.6 The auditor should update the audit plan to reflect the mix of financial
certification and control and compliance objectives established for the
current year.
6.2.7 The scope of the audit will reflect the audit entity. For audits that are
required under Section 7 of the Auditor-General Ordinance, the entity to be
audited will be defined by the applicable accounting policies of the
government. For example, for an audit of the financial statements of the
Federation, the entity to be audited would be all of the ministries,
departments, agencies, etc. that the accounting policies require to be
included in the financial statements of the Federation.
The audit objective
should be a clear
statement of what the
auditor intends to
examine and what is to
be achieved by the audit.
Objectives should be
defined for each
component.
Audit scope is a
statement of what areas
will be looked at, what
work must be done and
the methodology.
Audit Manual – Chapter 6
6-5
Step 2 – Understand entity’s business
6.2.8 The auditor should assemble and review material that will enable the team
to gain a sufficient knowledge of the business to assess materiality,
determine components, identify error conditions, etc.
Step 3 – Assess materiality, planned precision, and audit risk
6.2.9 Materiality, planned precision and audit risk are key concepts when
conducting an audit that will result in the Auditor-General expressing an
opinion on the financial statements of an audit entity. The opinion
paragraph of a standard unqualified auditor’s report commences, “In my
opinion, these financial statements properly present, in all material respects,
the financial position of [the entity] …”
6.2.10
Materiality. When the Auditor-General states that the financial statements
“properly present, in all material respects”, he/she is stating that the
financial statements are not materially misstated. An error (or the sum of
the errors) is material if the error (or the sum of the errors) is big enough to
influence the users of the financial statements. Therefore the auditor must
determine what amount is considered material.
6.2.11
Planned precision. Planned precision is the auditor’s planned allowance for
further possible errors. To determine it, the auditor first estimates the most
likely error that will exist in the financial statements as a whole. This
estimate is referred to as the “expected aggregate error.” The auditor then
subtracts the expected aggregate error from the materiality amount to arrive
at planned precision.
6.2.12
Audit risk. The opinion paragraph of the standard unqualified auditor’s
report begins “In my opinion …” This means that the auditor is not stating
that he/she is absolutely certain that the financial statements “properly
present in all material respects” (i.e., are not materially misstated). Rather,
the auditor is stating that he/she has some degree of assurance that is less
than 100% that the financial statements are not materially misstated. GAAS
refers to this degree of assurance as “reasonable assurance”.
6.2.13 The auditor should determine what level of confidence is required. If the
auditor wants to be 95% confident that the financial statements are not
materially misstated, this means that the auditor is prepared to take a 5%
risk that he/she will fail to detect errors summing to more than the
materiality amount. Audit risk in this case is therefore 5%.
6.2.14 Using a 5% audit risk and a Rs. 3,000,000 materiality amount, when the
auditor states, “In my opinion, these financial statements present fairly, in
all material respects …”, the auditor is stating, “I have 95% assurance that
the financial statements are not misstated by more than Rs. 3,000,000”.
Materiality, planned
precision and audit
risk are key concepts
when conducting an
audit
The auditor must
determine what
amount is considered
material.
6-6
Audit Manual – Chapter 6
Step 4 – Understand entity’s internal control structure
6.2.15 GAAS require the auditor to have an up-to-date understanding of the
entity’s internal control structure.
6.2.16 The required level of understanding depends on the extent to which the
auditor intends to rely on the internal controls to reduce his/her substantive
tests. Even when no reliance is intended, some knowledge is still required.
Step 5 – Determine components
6.2.17 Auditors normally do not plan audits for the financial statements as a
whole. Rather, they divide the financial statements into parts and plan each
part separately.
6.2.18 For an audit of financial statements, the most logical way of dividing up the
financial statements is to consider each line item in the financial statements
to be a separate component.
6.2.19 Sometimes the financial statements include several different groupings of
the same total amount. For example, expenditures may be grouped by:
a) The ministries, departments, agencies, etc. making up the reporting entity;
b) Appropriation account;
c) Economic function (general public services, defence affairs and services,
etc.); and/or
d) Object element (payroll expenditures, operating expenditures, civil works,
etc.).
6.2.20 The auditor normally selects the grouping that makes it the easiest to plan,
perform and evaluate the audit work.
6.2.21 If the financial statements group the expenditures by object element, the
auditor might then plan the audit of each object element to obtain the
desired assurance that errors in each object element do not sum to more
than the materiality amount.
Step 6 – Determine financial audit and compliance with authority objectives,
and error/irregularity conditions
6.2.22 Having divided the audit into components, the auditor needs to define attest
and compliance objectives, as applicable, and define what is considered to
be an error or irregularity.
6.2.23
Specific financial audit objectives. For a financial statement audit, a
component is considered to be in error if:
The auditor must
have an
understanding of the
entity’s internal
control structure.
Audit Manual – Chapter 6
6-7
a) It is not valid (the asset or liability does not exist or the revenue or
expenditure has not occurred) – the
existence objective; or
b) The statement of the asset, liability, revenue or expenditure is not complete
– the
completeness objective; or
c) The asset is not owned by the entity, or the liability is not owed by the
entity – the
regularity objective; or
d) The asset or liability is not properly valued or is misclassified, or the
revenue or expenditure is not properly measured or is misclassified - the
valuation or
measurement objective; or
e) The financial statement presentation is not proper – the
presentation
objective.
6.2.24
Related compliance with authority objectives. Section 3.4 of DAGP’s
auditing standards states,
“In conducting regularity (financial) audits, a test
should be made of compliance with applicable laws and regulations.”
6.2.25 To comply with this standard, the auditor should test for compliance with
those laws and regulations that are related to the audit of the financial
statements.
6.2.26 The following compliance with authority objectives are considered to be
applicable:
6.2.27
Spend:
a) The services were performed or the goods received;
b) The expenditure was consistent with the nature of the appropriation to
which it was charged;
c) The expenditure is in accordance with applicable legislation and the rules
and regulations issued by such legislation; and
d) The expenditure does not result in the total approved expenditure being
exceeded.
6.2.28
Borrow:
The amount and debt terms (period, interest rates, repayment schedule, etc.) are
in accordance with applicable legislation, and related rules and regulations.
6.2.29
Raise revenue:
a) The cash received was for an approved tax or other approved source;
b) The cash received is in accordance with applicable legislation and
associated rules and regulations.
6.2.30
Error conditions. The last part to this step is to consider error conditions.
The idea here is to consider possible ways in which an asset, liability,
revenue or expenditure might not be valid, complete, compliant with
applicable authorities etc. Put another way, the idea is to think of possible
ways in which a monetary error can occur in the financial statements and
the ways in which monetary amounts may not be in accordance with
applicable authorities.
6-8
Audit Manual – Chapter 6
6.2.31 For example, to apply the validity and measurement objectives to the
component “payroll expenditures”, the auditor should consider how payroll
expenditures might not be complete.
6.2.32 There are many possible reasons why payroll expenditures might not be
valid or properly measured. However the chance of some of them occurring
might be negligible. Similarly, the maximum possible error that could result
from some of them might be insignificant. The idea is to identify the errors
that have a real chance of occurring, and that could be relatively large in
relation to the materiality amount.
6.2.33 For the validity and measurement objectives, the auditor may identify four
error conditions, as follows:
a) Services paid for are not performed;
b) Employees are being paid more or less than they should be paid;
c) Payroll expenditures are being charged to an incorrect account or
appropriation; and
d) The amounts in the payroll register are not included in the financial
statements at the correct amount.
6.2.34 In addition, the auditor might also identify the following compliance with
authority matters:
a) the work being performed was not properly approved; and
b) the payments were not properly approved.
6.2.35 The auditor should then develop audit procedures to determine whether any
of the possible errors or deviations have occurred.
Step 7 – Assess inherent risk and control risk
6.2.36
Inherent risk. Inherent risk is the chance of material error occurring in the
first place assuming that there are no internal controls in place. “Material
error” may be a single error or the sum of multiple smaller errors.
6.2.37 Inherent risk is assessed at this stage as it determines how much testing of
internal controls and substantive testing (analytical procedures and
substantive tests of details) the auditor needs to perform in total to achieve
his/her desired level of reasonable assurance (95% in our illustration).
6.2.38
Control risk. Control risk is the chance that the entity’s internal controls
will not prevent or detect material error. Again, “material error” may be one
error or the sum of multiple smaller errors.
6.2.39 Control risk is assessed at this stage as it determines the amount of
assurance that the auditor can obtain from his/her tests of internal control.
Audit Manual – Chapter 6
6-9
Step 8 – Determine mix of tests of internal control, analytical procedures and
substantive tests of details
6.2.40 The auditor needs to select a combination of tests of internal control,
analytical procedures and substantive tests of details that, in total, will
provide the desired level of assurance that payroll expenditures are not
incomplete by an amount greater than the materiality amount.
6.2.41 The auditor can obtain this assurance in a number of ways, for example by:
a) reviewing the internal controls that the entity has in place to ensure the
completeness of, using our payroll example, payroll expenditures, and then
performing tests of internal control to ensure that the controls are
functioning properly;
b) performing such analytical procedures as comparing the payroll
expenditures by month to each other and to the equivalent amounts in the
previous year; and/or
c) selecting a sample of payroll transactions and performing various
substantive tests of details on those transactions.
6.2.42 These methods can be used in different combinations. For example:
a) Place a lot of reliance on the internal controls. Under this option, the auditor
would perform a lot of tests of internal control, supplemented by only
limited analytical procedures, and select a very small sample of payroll
transactions for substantive tests of details; or,
b) Place very little reliance on the internal controls. Under this option, the
auditor would do fewer tests of internal control than in the first option, but
would perform more rigorous analytical procedures and/or select a larger
sample of payroll transactions for substantive tests of details.
6.2.43 When deciding which combination to use, the auditor should consider
several factors, including the cost of each combination in terms of audit
resources.
6.3 Activity and Resource Planning
6.3.1 This phase primarily involves taking the decisions made during the general
planning phase and using them to build the audit programmes that will be
used during the fieldwork phase. It also involves establishing budgets,
staffing requirements, the timing of the audit work, and the information to
be obtained from the entity.
6.3.2 These steps are introduced below, and are discussed in more detail later.
Develop audit programmes
6.3.3 The audit programmes provide the auditor with a list of all the procedures
to perform.
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Audit Manual – Chapter 6
6.3.4 The auditor can use the error conditions identified during the general
planning phase, or a previous audit programme for the entity, as a starting
point for the development of the audit programmes.
6.3.5 The auditor should also determine what information the entity management
are required to make available for the audit work.
Establish resource requirements and timing considerations
6.3.6 For each audit determine:
a) the number of auditors with required level of seniority and skill sets;
b) related out-of-pocket expense budgets; and,
c) timing of the work.
6.3.7 The resource requirements are based on the audit programmes. Resource
allocations from previous audits of the entity may provide a helpful starting
point.
Fieldwork
6.3.8 During the fieldwork phase, the auditors complete the procedures that are
contained in the audit programmes. The required evidence is gathered, and
the work performed is documented in the appropriate working paper files.
6.3.9 Chapter 8 contains detailed guidance on this phase of the audit cycle.
Evaluation
6.3.10 During the evaluation phase, the results of the audit are summarised and
conclusions are reached.
6.3.11 The auditor first concludes on the results of each test. The auditor then
reaches a conclusion on each component. Finally, the auditor reaches a
conclusion on the financial statements as a whole, and/or identifies specific
irregularities and general systemic weaknesses based on compliance with
authority tests.
6.3.12 Chapter 9 contains detailed guidance on this phase of the audit cycle.
Reporting
6.3.13 The reporting phase involves performing some final clearance procedures
and issuing an audit certificate (opinion) on the financial statements. In this
certificate, the auditor expresses an opinion as to whether:
a) the financial statements properly present in all material respects, the
government’s financial position, the results of its operations, its cash flows
and its expenditure and receipts by appropriation; and,
Audit Manual – Chapter 6
6-11
b) the sums expended have been applied, in all material respects, for the
purposes authorised by Parliament, and have, in all material respects, been
booked to the relevant grants and appropriations.
6.3.14 Often, the reporting phase also involves issuing other reports dealing with
internal controls, compliance with authorities, and performance matters that
were identified as part of a financial audit, or in separate audits. These
matters can be reported in a management report or in one of the Auditor-
General’s reports to Parliament and the Public Accounts Committee.
6.3.15 Chapter 10 contains detailed guidance on this phase of the audit cycle.
Follow up
6.3.16 The follow-up phase involves returning to the entity at a later date to
determine if entity management has:
a) Corrected errors identified during the audit; and
b) Implemented recommendations made by the auditors or by the Public
Accounts Committee.
6.3.17 Chapter 11 contains detailed guidance on this phase of the audit cycle.
6.4 Roles and Responsibilities
General Roles and Responsibilities
6.4.1 The general planning phase is where most of the key planning decisions are
made. Many of these decisions have a significant impact on the nature,
extent and timing of the work that is performed during the fieldwork phase.
Because of this, general planning decisions should be made by the more
senior and experienced members of the audit directorate.
6.4.2 Similarly, conclusions reached during the evaluation phase may have a
significant impact on the type of audit report that is issued. The more senior
and experienced members of the audit directorate also need to be directly
involved in the evaluation process, and in the finalisation of the report.
6.4.3 It is not possible to lay down specific roles and responsibilities for all
audits. Each audit is different – some are quite complex and difficult to plan
and perform; others are relatively small and straightforward. In addition,
there may be differences in the knowledge of the entity and audit skills
possessed by different staff members within each directorate.
6.4.4 To encourage consistency, Figure 6.2 contains a chart that shows the
suggested roles and responsibilities of individuals at each level, for the
general tasks to be performed during the audit.
Centrally Led Audits
Key planning
decisions impact the
nature, extent and
timing of the work.
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Audit Manual – Chapter 6
6.4.5 These are audits where a central team is responsible for the overall
planning, performance, evaluation, reporting and follow up. An example of
such an audit is the annual audit of the financial statements of the
Federation.
6.4.6 With a centrally led audit, there will be a division of responsibilities
between the central team and each directorate. For example, for the annual
audit of the financial statements of the Federation, the central team is
responsible for:
a) Setting the basic planning parameters (materiality, planned precision, audit
risk, components, etc.);
b) Setting inherent risk, control risk, other substantive procedures risk and
substantive test of details risk for each component and each specific
financial audit objective and compliance with authority objective and error
condition;
c) Determining the optimum mix of tests of internal control, analytical
procedures and substantive tests of details for each component and for each
specific financial audit objective and related compliance with authority
objective and error condition;
d) Drafting the audit programmes, forms and checklists to be used by the audit
teams performing the work;
e) Performing the overall error evaluation; and
f) Reporting the results of the audit.
6.4.7 The auditors from each of the directorates are, in turn, responsible for:
a) Providing advice to assist the central team to plan the audit;
b) Reviewing the material received from the central team to ensure audit
programmes, forms and checklists reflect the optimum mix of tests for that
particular directorate, and contain all the work required to obtain the
required amount of overall assurance;
c) Performing the audit work; and
d) Reporting the results of the work, including individual errors and other
matters of note, to the central team.
6.4.8 Regarding the above, the central team will likely not have the same detailed
level of knowledge of a particular entity as the auditors from the applicable
audit directorate. For example the central team may not be aware that the
internal controls are weak and that the planned level of reliance on them is
not possible. The auditors from the audit directorate must bring these
matters to the attention of the central team and ensure necessary
adjustments are made to the audit plan.
Audit Manual – Chapter 6
6-13
6.4.9 With a centrally led audit, some of the roles and responsibilities that,
according to Figure 6.2, are to be performed by the Director General will be
performed by the Director General responsible for the central team, while
other roles and responsibilities will be performed by the Director General in
charge of each directorate. The same applies to the other levels of staff
shown in Figure 6.2.
6.4.10 To ensure that everyone is aware of their roles and responsibilities, the
central team will provide a schedule similar to Figure 6.2 that clearly lays
out the roles and responsibilities of individuals within the central team, and
within each audit directorate.
Figure 6.2: Roles and Responsibilities
Step
Auditor-
General
DAG
(Senior)
or DAG
Director
General Director
Deputy
Director or
Asst. Director
Audit
Officer
General Planning
Update overall audit
objectives and audit
scope
A
(1) R(1) P
Update understanding
of entity’s business
A
(1) R(1) P
Update assessment of
materiality, planned
precision, and audit risk
A
(1) R(1) P
Update understanding
of the entity’s internal
control structure
A
(1) R(1) P
Update determination
of components
A
(1) R(1) P
A = Approve R = Review S = Supervise
P = Responsible for performance of.
(1)
The review and approval would be done through a review and approval of the permanent file,
planning file, audit planning memorandum, audit programmes, etc. produced at the end of the
planning process.
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Audit Manual – Chapter 6
Detailed Planning
Update audit
programmes
A
(1) R(1) S P
Update budgets,
staffing requirements,
timing considerations,
etc.
A
(1) R(1) S P
Fieldwork
Complete audit
programmes R S P
A = Approve R = Review S = Supervise
P = Responsible for performance of.
(1)
The review and approval would be done through a review and approval of the permanent file,
planning file, audit planning memorandum, audit programmes, etc. produced at the end of the planning
process.
Step
Auditor-
General
DAG
(Senior)
or DAG
Director
General Director
Deputy
Director
or Asst.
Director
Audit
Officer
Update determination
of specific financial
audit objectives,
compliance with
authority objectives
and error conditions
A
(1) R(1) P
Update assessment of
inherent risk and
control risk
A
(1) R(1) P
Update optimum
combination of
procedures
A
(1) R(1) P
Audit Manual – Chapter 6
6-15
Step
Auditor-
General
DAG
(Senior)
or DAG
Director
General Director
Deputy
Director
or Asst.
Director
Audit
Officer
Evaluation
Conclude on results
of work
R S P
Reporting
Audit Opinions A
(2) A(2) R P
Audit Reports
A(2) A(2) R P
Management
reports
A P
Follow up
Follow up matters in
reports
(3) (3) (3) (3) (3) (3)
A = Approve R = Review S = Supervise
P = Responsible for performance of.
(2) It is expected that the audit opinions and audit reports on the major entities would be approved by the
Auditor-General; the other audit opinions and audit reports would be approved by the Deputy Auditor
General (Senior) or a Deputy Auditor General.
(3) The roles and responsibilities would match those for the equivalent work performed during the audit
itself.
Audit Manual – Chapter 7
7-1
7. PLANNING THE AUDIT
7.1 Introduction
7.1.1 Individual audits must be properly planned to ensure:
a) Appropriate and sufficient evidence is obtained to support the auditor’s
opinion;
b) DAGP’s auditing standards are complied with; and
c) Only necessary work is performed.
7.1.2 This chapter contains guidelines that the auditor can use to plan the audit.
These guidelines do not replace the use of professional judgment.
7.2 Step 1 – Establish Audit Objectives and Scope
7.2.1 It is a general principle of DAGP’s audit activities that no audit entity
should be subject to more than one audit in a given year. Accordingly, any
individual audit may have to fulfil multiple audit objectives, so it is
important that the audit is well-planned in terms of audit objectives and
audit scope.
7.2.2 The step also involves communicating with the entity to ensure
management is fully aware of the audit objectives and audit scope.
Overall Audit Objectives
7.2.3 Each audit will be designed to address one or more of the following
objectives:
a) Expressing an opinion on financial statements;
b) Expressing an opinion regarding compliance with authorities;
c) Testing compliance with authority or controls on selected transactions with
no opinion being expressed; and
d) Evaluating operational performance.
7.2.4 To express an opinion on financial statements the auditor needs to design
audit procedures to obtain a reasonable level of assurance that the financial
statements are not materially misstated. This means reaching a conclusion
as to whether the account balances are valid, are complete, are properly
valued, etc.
7.2.5 For compliance with authority work where an opinion is being expressed,
the auditor will design audit procedures to obtain a reasonable level of
assurance that the selected transactions in a given period are in compliance
with applicable statutes and regulations. The types of irregularities that the
auditor needs to look for will reflect the objectives of the compliance audit.
Individual audits
must be properly
planned.
The auditor needs to
design audit
procedures to obtain
a reasonable level of
assurance that the
financial statements
are not materially
misstated
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Audit Manual – Chapter 7
7.2.6 For compliance with authority audit work where there is no expression of
an opinion the auditor need not plan the audit to obtain a specified
minimum level of overall audit assurance.
7.2.7 Where the audit is to evaluate operational performance the auditor is
concerned with economy, efficiency and effectiveness the auditor will
develop specific audit objectives and conclude on the management
framework and/or level of performance.
7.2.8 In summary, the nature and extent of the work that the auditor needs to
perform will vary according to the objectives of the audit. Therefore, a first
step in the planning process is to determine the objectives for the year.
Audit Scope
7.2.9 The auditor also needs to determine the overall audit scope – the total
population on which to express an opinion, from which to select
transactions, etc. For financial audit purpose, this total population is
referred to as the “audit entity”. The audit entity determines the scope of
the audit, and is generally defined by the audit mandate. For financial
statement audits that are required under Section 7 of the Auditor-General
Ordinance (see Chapter 2), the entity to be audited will be defined by the
applicable accounting policies of the government.
7.2.10 For example, the accounting policies for the Federation state, “The financial
statements have been prepared by consolidating the accounts of all
Centralised and Self Accounting Entities …. Commercial entities owned or
controlled by the Government prepare their own financial statements, which
are not included in these financial statements.” Based on this accounting
policy, the audit entity would include all centralised and self-accounting
entities, but would exclude the commercial entities.
7.2.11 For other financial audits, the entity to be audited may need to be carefully
determined. For example, a ministry may make use of a special operating
agency to perform some of its functions. In this situation, the auditor will
need to determine whether or not the agency falls under the scope of the
audit.
7.2.12 In some cases, the scope of the audit can be at the auditor’s discretion, or
can be negotiated with entity management. For example, DAGP may have
planned to audit a particular civil works project. If the internal audit unit in
that entity is planning to do a detailed audit of the project one year later, it
may suggest that DAGP defer its audit by a year so the two audits could be
coordinated. DAGP might decide to do so.
7.2.13 The first consideration in defining the scope of audit is to ensure that the
work required to complete the financial attest audit is covered. In
determining what else should be audited, it is important that scarce audit
resources be focused on the most important aspects of the operations of the
government. The first step in deciding what to examine is to identify
matters of significance, both within the government as a whole and within
the audit entity under examination.
The auditor needs to
determine the overall
audit scope – the
“audit entity”.
Audit Manual – Chapter 7
7-3
7.2.14 Matters of significance can include one or more of the following:
a) Large expenditures or large revenues;
b) Areas of high risk (significant control weaknesses, potential for large
losses/negative impacts);
c) Matters of propriety, or probity (even if not of high materiality or risk);
d) Important aspects of the programme’s performance;
e) Politically sensitive areas, where the reputation of the government could be
adversely affected;
f) Substantial errors or misrepresentations in financial and other management
reports;
g) Serious problems of compliance, especially regarding laws and regulations;
and
h) Areas where the audit is likely to identify opportunities for significant
improvement.
7.2.15 The auditor may decide to address one or more of these or to limit audit
coverage to financial attest requirements together with the more critical
aspects of compliance with key laws and regulations. Ultimately the
decision as to what sub-entities are significant and should be included in a
particular audit is a matter for DAGP management. As noted in Chapter 5,
there are various entities that DAGP may decide to include in any specific
audit. Entities may be organisational units, such as agencies, DAOs, DDOs
etc., functional areas, such as the payroll function or the purchasing
function, or accounting entities, such as objects of expenditure, grants or
appropriations. DAGP may determine that all entities should be reviewed
in a particular audit, for example ensuring complete coverage of all DDOs
or grants and appropriations, and the planning phase for individual audits
will be guided by this direction from management.
7.2.16 In determining what areas are significant, an understanding of the audit
entity and its business is important. In selecting matters of significance for
performance audits, the auditor should not focus only on the potential of
negative findings. It is also important that key aspects of the programme are
examined even if they are well managed. Providing the Legislature, the
public, and also management, with assurances that programmes are well
administered can be of value. When providing an assurance, the auditor
must obtain sufficient evidence to conclude that there is a low risk that any
significant problem has gone undetected. This usually requires much more
audit effort than is required for finding weaknesses.
Entity Communication Letters
7.2.17 DAGP has a legal mandate to perform its audit work. This mandate permits
it to determine the nature, extent and timing of its work. As such, DAGP
does not need to negotiate the scope of its work with the entity, or to make
use of formal engagement letters.
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Audit Manual – Chapter 7
7.2.18 Nevertheless, there are benefits to discussing the nature, extent and timing
of the work with entity officials. These benefits include:
a) The introduction of annual financial audit work has changed the nature of
the audit work that the auditors are performing. Entity communication
letters can be used to help the audit entities to better understand the nature
of the work that is being performed, and the types of reports that may be
issued at the completion of the work.
b) While much of the financial audit work will be performed annually, other
work that DAGP performs will continue to be performed on a rotational
basis. Entity communication letters can be used to advise the entity of the
nature, extent and timing of the rotational audit work that will be performed
in the coming year.
c) Input from entity management may help improve the planned scope of the
audit and the rotational audit plan. For example, the auditors may discover
that the entity’s internal audit unit is planning a detailed review of the
entity’s internal control structure. DAGP and internal auditors could then
coordinate their work, and the DAGP auditors may be able to rely on the
work performed by the internal auditors.
d) Input from entity management may also improve the efficiency of the audit
work. For example, the auditors could advise entity officials of the planned
start and completion dates of each audit, and the information that the
auditors will require to perform their audit. Entity officials would then be
able to locate the required information, arrange for suitable office space,
etc. prior to the start of the audit.
7.2.19 An entity communication letter is a useful way to document the nature,
extent and timing of the audit work that will be performed in the following
year. A sample letter is included in the Standard Audit Working Paper Kit.
7.3 Step 2 – Understand the Entity’s Business
Information Requirements
7.3.1 Audit objectives are developed on the basis of an understanding of the
entity’s business. However, the auditor does not need to have a complete
understanding of all of the entity’s activities. The auditor only needs to
have a detailed knowledge of those aspects of the entity’s business that
relate to the audit.
7.3.2 For example, when performing a financial statement audit, the auditor may
not need to have a detailed understanding of all of the entity’s human
resource policies. However, should the auditor be performing a compliance
with authority or a performance audit on the staffing and promotion
processes, a more detailed understanding of the human resource policies
may be required.
7.3.3 The auditor should assemble the following information for most audits:
a) government’s plans and priorities;
b) entity’s strategic plans;
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c) users of the entity’s services;
d) legislative authorities affecting the entity’s operations;
e) industry in which the entity operates, including any specialised accounting
practices followed by that industry;
f) activities in which the entity engages (constructing buildings, providing
grants and contributions, collecting taxes, etc.);
g) size of the entity (its total assets, liabilities, revenue and expenditure);
h) types of transactions and documents that the entity processes;
i) entity’s internal control structure; and
j) economic trends that can affect the valuation of significant assets and
liabilities (those held in foreign currencies, for example).
7.3.4 The Standard Audit Working Paper Kit includes forms to help the auditor
update his/her understanding of each of these knowledge areas.
7.3.5 Sufficient knowledge of these matters is required by the auditor to:
a) assess materiality, planned precision and audit risk;
b) understand the internal control structure;
c) determine components and understand how the various components and
activities fit together;
d) identify error conditions;
e) assess inherent risk and control risk;
f) understand the substance of transactions, as opposed to their form;
g) identify the nature and sources of audit evidence that are available;
h) update audit programmes;
i) assess whether sufficient appropriate audit evidence has been obtained;
j) assess the appropriateness of the accounting policies being used; and
k) evaluate the presentation of financial statements and the reasonableness of
the overall results.
7.3.6 There is a link between these knowledge areas and the tasks to be
performed, as follows:
a) an understanding of the users of the entity’s services and the size of the
entity is needed to assess materiality;
b) an understanding of the legislative authorities affecting the entity’s
operations, the activities in which the entity engages, and the types of
transactions and documents that the entity processes is needed to determine
what components to audit;
c) an understanding of the industry in which the entity operates, the activities
in which the entity engages, the size of the entity, the types of transactions
and documents that the entity processes, and economic trends are needed to
assess inherent risk.
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Level of Effort
7.3.7 Building an understanding of the entity’s business can be a significant
undertaking especially where the audit scope is large, like the audit of the
Federal Government. The level of effort in collecting and documenting the
understanding will be high, especially when this is being done for the first
time. Practically, DAGP will probably have to approach this effort
incrementally over the course of the first few audit cycles. However, this
should be done according to a plan that will ensure adequate depth of
understanding of priority issues to provide a foundation upon which
subsequent audit cycles can build.
7.3.8 There are a number of factors that can legitimately reduce the effort
required:
a) Much of the required knowledge will have already been gathered during
prior compliance with authority work. This can be used when planning the
audit.
b) With a financial audit, the depth of knowledge required of each ministry,
department etc. is relative to the materiality of that organisational unit to the
overall audit scope. Therefore, the knowledge required will be small for
less material agencies and will be of lower priority, so it can be deferred
until more priority units have been covered.
c) The depth of knowledge required also reflects the extent of intended
reliance on internal controls as a source of audit assurance. If the auditor
intends to place little reliance upon internal controls, then a lower level of
knowledge is required than when significant reliance is to be placed on
controls.
7.3.9 These factors can reduce the level of knowledge needed, and can render the
data gathering exercise more manageable.
7.3.10 Once the required level of knowledge has been reached, over the course of
several audit cycles, subsequent audits need only be concerned with
confirming the knowledge is current and updating specific issues where
necessary.
7.3.11 Clearly, knowledge of the business is important to all phases of the audit.
The auditor should therefore be sure to update his/her knowledge of the
entity’s business throughout the audit. Analytical procedures are often used
at the general planning phase to identify large fluctuations in the accounts
from the previous year. These fluctuations, in turn, may indicate changes in
the entity’s operations.
7.3.12 Analytical procedures are discussed in more detail below.
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7.4 Step 3 – Assess materiality, planned precision, and
audit risk
Materiality
7.4.1
Definition of materiality: When the auditor states that the financial
statements “properly present, in all material respects”, he/she is stating that
the financial statements are not materially misstated. This introduces the
concept of materiality.
7.4.2 Materiality can be defined as follows: “An error (or the sum of the errors) is
material if the error (or the sum of the errors) is big enough to influence the
users of the financial statements”.
7.4.3 Materiality is important in the context of the auditor’s report on the
financial statements. The opinion paragraph of a standard unqualified
auditor’s report commences, “In my opinion, these financial statements
properly present, in all material respects, the financial position of [the
entity] …”
7.4.4
Guidelines: To determine materiality the auditor should perform the
following steps:
1. Identify the probable users of the financial statements.
2. Identify the information in the financial statements that is expected to
be the most important to each of these users (e.g., total expenditures,
total assets or the annual surplus or deficit). One or more of these
amounts may serve as the base amount(s) for computing materiality.
3. Estimate the highest percentage(s) by which the base amount(s) could
be misstated without significantly affecting the decisions of the users
of the financial statements.
4. Multiply the percentage(s) times the base amount(s).
5. Select the lowest amount – this is the materiality amount. Errors
exceeding this value are material.
7.4.5 The auditor normally selects the lowest amount that results from each of
these guidelines, and uses that amount for the audit of the financial
statements as a whole. This is because errors often affect more than one
component. For example, an error in cash may also represent an error in
expenditures. As a result, the auditor cannot use a higher materiality
amount to audit cash than he/she uses to audit expenditures.
7.4.6 Note that the materiality amount determined at this step in the general
planning phase is used for the audit of
all components. There is no need to
allocate the amount to the various financial statement components. If
materiality is set at Rs. 3,000,000 for the financial statements as a whole,
the same Rs. 3,000,000 can be used for each financial statement
component, and for each specific financial audit objective, related
compliance with authority objective, and error condition.
An error is material
if the error is big
enough to influence
the users of the
financial
statements.
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7.4.7 There are some guidelines that can be used to determine the base amount(s)
and the appropriate percentage(s). While guidelines should not replace the
use of professional judgment, the following may be useful, depending on
the nature of the entity being audited:
7.4.8 Percentage of total expenditures.
This method is the most widely used method for
not-for-profit public sector
entities. The percentages used generally range from 2% for "small" entities
to 0.5% for "large" entities.
7.4.9 Percentage of normalised pre-tax income.
This method is the most used method for
profit-oriented public sector
entities (e.g., state-owned enterprises with a mandate to earn a return on
their investments). The percentages used generally range from 5% for
entities with "large" pre-tax incomes to 10% for entities with "small" pretax
incomes.
7.4.10 Percentage of total revenue.
The same 2% to 0.5% range that is generally used for expenditures (see
above) is often recommended.
7.4.11 Percentage of equity.
Usually 1% is suggested. This method would be appropriate only for
entities following full accrual accounting and hence recording such assets
as receivables, stocks and fixed assets. Without these assets, the entity
would most likely be in an accumulated deficit position, and the equity
amount might not be meaningful to the users.
7.4.12 Percentage of assets.
Usually 0.5% is suggested, which achieves the same materiality amount as
the amount in Percentage of Equity if the debt-to-equity ratio is 1 to 1.
7.4.13 Percentage of the annual surplus or deficit.
For public sector entities, the most often quoted amount in the media is the
annual surplus or deficit. It would therefore seem logical to base materiality
on a percentage of the entity’s annual surplus or deficit.
7.4.14 However, there are weaknesses in the latter approach. The main weakness
with basing materiality on a percentage of the annual surplus or deficit is
the fact that the amount may not represent the "true" size of the entity. An
entity with an extremely small annual deficit relative to its total
expenditures and revenues would have an extremely small materiality
amount, and an entity with a very large annual deficit would have a very
large materiality amount. In fact, basing materiality on the annual surplus or
deficit could result in the materiality amount decreasing year after year
even though the size of the entity being audited is increasing.
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7.4.15 Because of these problems, a percentage of the annual surplus or deficit is
normally only used as a reasonableness check on the materiality amount
determined by a percentage of total expenditures or revenues.
7.4.16 It is
not necessary to use a percentage of total expenditures or revenue to
audit the statement of expenditures and revenues, a percentage of total
assets when auditing the balance sheet, etc. Instead, the auditor selects the
lowest amount that results from each of these guidelines and uses that
amount for the audit of the financial statements as a whole. That is because
errors often affect more than one component.
7.4.17 Also note that available audit resources should
not be a factor in setting
materiality. Materiality is determined with the users in mind, and it is up to
the auditor to ensure that it has the resources that are required to perform
the work.
7.4.18 The Standard Audit Working Paper Kit contains a form that can be used to
assess the materiality amount.
7.4.19 Ultimately, the establishment of an appropriate materiality amount is a
matter for the auditor’s professional judgment. For this reason, it is
normally
not appropriate to use the same materiality amount for the audit of
different entities (i.e. the materiality calculated for the Federal Government
as one entity, will be different from the materiality for a self-accounting
commercial enterprise), and materiality should be calculated separately for
each audit. In addition if, based on the knowledge of the entity and an
understanding of the circumstances, the auditor believes that the monetary
amount determined by the above process appears unreasonable, additional
relevant factors should be considered and the materiality amount revised
accordingly.
7.4.20
Qualitative aspects. In addition to the quantitative aspects of materiality
discussed above, there is also a
qualitative aspect. The inherent nature or a
characteristic of an error may render the error material, even if its value is
not. For example, a small error that is designed to conceal the overexpenditure
of a government appropriation could be considered to be
material by the users.
7.4.21 Auditors are not expected to plan financial audits to detect all of these
qualitative errors. The cost of such an audit would be too high.
Consequently, auditors normally ignore the qualitative aspects of errors
when planning their audits. However, when reporting on the results of the
audit work, they take into account the qualitative aspects of the errors that
they have found when assessing whether the financial statements taken as a
whole are presented fairly.
Planned Precision
7.4.22 Planned precision is the auditor’s planned allowance for further possible
errors.
7.4.23 By testing a sample, the auditor can determine the Most Likely Error
(MLE) in the population. However, because the auditor has only selected a
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sample, there is a chance that the actual error in the population is larger
than that. The auditor needs to ensure there is sufficient assurance that the
maximum possible error in the population is less than the materiality
amount.
7.4.24 To do this, when planning and performing many analytical procedures and
substantive tests of details, the auditor reduces the materiality amount by
his/her estimate of the most likely error that will exist in the financial
statements as a whole. This estimate is referred to as the “expected
aggregate error.” Planned precision is equal to materiality less the expected
aggregate error.
7.4.25 To determine the expected aggregate error, the auditor should consider:
a) The errors found in previous years;
b) Changes the entity has made to the internal control structure to prevent
these errors from recurring; and
c) Other changes to the entity’s business or its internal control structure that
could affect the size of the errors.
7.4.26 If the auditor’s estimate of the expected aggregate error had been set at the
planning stage at Rs. 816,500, the auditor would have calculated planned
precision as follows:
Materiality Rs.
3,000,000
Expected aggregate error in financial statements 816,500
Planned precision Rs. 2,183,500
7.4.27 As noted in the discussion on materiality, the materiality amount
determined at this step of the general planning phase is used for the audit of
all components within the same audit. There is no need to allocate the
amount to the various financial statement components. Consistent with this
approach, the expected aggregate error being used for a particular test is the
expected aggregate error in the financial statements as a whole, and
not just
the expected error in the population being audited. When auditing the
completeness of income tax receipts, for example, the auditor would need
to allow for errors not only in that test, but for errors found in other income
tax receipts tests and for errors found in other financial statement
components.
Audit Risk
7.4.28
Definition: The opinion paragraph of the standard unqualified auditor’s
report begins “In my opinion …” This means that the auditor is not stating
that he/she is absolutely certain that the financial statements properly
present the results of operations (i.e. they are not materially misstated).
Rather, the auditor is stating that he/she has some degree of assurance that
is less than 100% that the financial statements are not materially misstated.
The auditor is not
absolutely certain that
the financial
statements are not
materially misstated.
The auditor has some
degree of assurance
that it is less than
100%.
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Generally accepted auditing standards (GAAS) refer to this degree of
assurance as “reasonable assurance”.
7.4.29 Stated another way, the auditor is taking some risk of issuing an unqualified
opinion on financial statements that are materially misstated. This risk is
referred to as “audit risk”.
7.4.30 For example, if the auditor wants to be 95% confident that the financial
statements are not materially misstated, this means that the auditor is
prepared to take a 5% risk that he/she will fail to detect errors summing to
more than the materiality amount. Audit risk is therefore 5%.
7.4.31 Using the audit risk and the materiality amount, when the auditor states, “In
my opinion, these financial statements present fairly, in all material respects
…”, the auditor is stating, “I have x% assurance that the financial
statements are not misstated by more than the materiality amount”.
Risk Assessment
7.4.32 The audit should focus on the areas of greatest materiality, significance and
risk. An understanding of the risk associated with each audit entity is
therefore critical to the development of an audit plan. The auditor should
develop this understanding by conducting a risk assessment as part of
planning an audit assignment.
7.4.33 In the case of a
financial attest audit, the auditor is concerned with the risk
that material misstatements exist in the financial statements that will not be
detected, either by management or by audit procedures.
7.4.34 In the case of
compliance audits, the auditor is concerned with the risk that
certain material, or significant, transactions have occurred in a manner that
contravene the laws, regulations and management procedures applying to
the area of audit.
7.4.35 In considering audit risk, there are three categories of risk that are normally
considered: Inherent Risk, Control Risk, and Detection Risk. These are
discussed below.
1. Inherent risk
7.4.36 This is the susceptibility to material/significant error or loss unrelated to
any internal control system. Assessing inherent risk requires the evaluation
of numerous judgmental factors, relating to the nature of the entity and its
business environment taken as a whole.
An understanding of
risk is critical to the
development of an
audit plan.
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7.4.37 This is done by asking what could go wrong and what would be the likely
consequences. If the likelihood of occurrence is low and the significance of
the consequence is low, the auditor need not be concerned. Where the
likelihood is high and the significance is high, then inherent risk is high. In
this situation, the auditor must be assured that either the internal controls
are strong enough to detect and prevent such occurrences or the substantive
audit coverage is sufficient to detect such occurrences with a high level of
assurance.
2. Control risk
7.4.38 This is the risk that material/significant error or loss is not prevented or
detected on a timely basis by the internal control structure. Control risk is a
function of the effectiveness of the design and operation of the internal
controls. In order to assess control risk, the auditor should obtain evidence
to support the effectiveness of internal control policies and procedures in
preventing or detecting material error or loss. The auditor should recognise
that there are risks of error or loss that cannot be detected or prevented in a
timely manner whatever the controls in place. Further, the auditor should
recognise that the costs of certain controls cannot be justified when
compared to the potential losses they are guarding against.
7.4.39 The auditor should identify and evaluate both the control environment and
the effectiveness of the individual internal controls that are in place.
Indicators of a positive control environment include:
a) policies and procedures relating to internal controls and to the need for
maintaining a proper control environment exist and are documented;
b) an appropriate organisational structure with clearly identified roles and
responsibilities relating to the administration of internal controls exists;
staff are selected and trained to ensure their competence and dedication in
key control positions;
c) senior management is involved in identifying control risks and monitoring
performance;
d) actions are taken to correct any identified control deficiencies with an
appropriate level of priority; and
e) management displays positive attitudes towards the maintenance of sound
internal controls, such as: recognising dedicated effort; positively
responding to audits and reviews of controls; and taking disciplinary action
in response to poor performance.
7.4.40 The auditor is referred to the Control Environment Worksheet in the
Standard Audit Working Paper Kit.
7.4.41 To review the effectiveness of controls the auditor should make use of the
Internal Control Questionnaires which are presented in the audit
programme guides as part of the Standard Audit Working Paper Kit. The
auditor should expect stronger controls where risks are highest. For
example, there should be strong controls in place to ensure contracts
involving large expenditures are well managed: for the selection of the
contractor, for drawing up the contract; and for the control of performance
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under the contract. On the other hand, there should be minimal effort
applied to controlling small items of inventory where the risk of loss,
damage or theft is low.
7.4.42 The auditor should determine how the controls are applied, assess their
adequacy, and identify significant control gaps.
7.4.43 The trend in modern government is to “let the managers manage” and take
reasonable risks in order to achieve results with reduced resources.
Consequently, the auditor should be conscious of the need for reasonable,
but not excessive, internal controls. The cost of controls should not exceed
the potential losses that could occur without those controls.
3. Detection risk
7.4.44 This is the risk of material/significant error or loss going undetected by the
auditor’s substantive audit procedures. It is a function of the effectiveness
of the substantive audit procedures and audit effort.
7.4.45 Also, less experienced or less knowledgeable auditors are more likely to
miss detecting errors than the experienced auditor. Therefore, without
careful supervision, the employment of less experienced auditors increases
detection risk.
7.4.46
Audit risk is a composite of these three risks. When planning an audit
there is a trade off between the overall risk that the auditor will accept and
the cost of the audit – the lower the overall risk that the auditor is prepared
to take, the more extensive the required work and the more costly the audit
becomes. Thus the risk assessment process is particularly important in
determining the extent to which the audit will examine the systems,
procedures, practices and transactions that govern matters at the lower end
of the objective and control hierarchy.
4. Identification of Risk
7.4.47 The auditor needs to develop the ability to identify risks. This requires an
understanding of what constitutes risk and how to recognise it. There is a
set of steps that the auditor can take, but experience, imagination and
judgment are also critical.
7.4.48 The steps to follow are:
1 List the programme objectives, assets to be safeguarded and other results that
management need to achieve;
2 Identify threats which could prevent achievement of these objectives;
3 Rate the risks, with the probability of occurrence, assuming no management
controls (the inherent risks);
5. List controls and assurances which exist within the systems and practices in
place (environment controls and internal controls);
6. Identify missing controls and assurances;
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7. Identify risks that could occur even with the existing controls in place (control
risk); and
8. Recommend improved controls and assurances (based on an assessment of the
trade-off of the cost of the controls against the potential savings of lost and
waste without the new controls in place).
7.4.49 This activity should be documented on the audit file.
Indicators of Risk
7.4.50 There are certain indicators that can alert the auditor to potential risk
situations. Analysis of data may produce information that does not look
right. Managers are often aware of high-risk situations and will assist the
auditor to identify areas needing examination. This is more likely if the
manager sees the auditor as an ally rather than a critic and feels comfortable
confiding with the auditor.
7.4.51 Some examples of risk that can be encountered are:
a) Processing risk;
b) Programme risk;
c) Regulatory risk; or
d) Risk of fraud.
7.4.52
Processing risk. Errors can occur inadvertently, especially in situations
such as the following:
a) A new government programme where there is little experience in
administering it, or the entity has taken over responsibilities for a new
function and the previous administrators are no longer involved.
b) New systems or procedures are introduced, especially a new computerised
system.
c) There have been recent changes in management or there is a high turnover
of staff (in other words, there is a poor corporate memory), particularly if
administrative procedures are poorly documented.
d) There are unclear responsibilities.
7.4.53 If the process involves large transactions, the risk of inadvertent loss or
waste can be serious.
7.4.54
Programme risk. Certain government programmes are particularly
susceptible to significant losses, either intended (fraud) or unintended (the
result of poor administration).
7.4.55 Examples of programmes that should be given a careful assessment of risk
are:
a) Loans or guarantees, which, by their very nature, usually place the
government at risk.
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b) Programmes delivered by means of contracts, especially where there are
unclear terms and conditions, insufficient specifications / performance
requirements.
c) Research and development projects, where often the results are difficult to
predict (especially non-standard software development).
d) Programmes with vague outputs or outcomes, where in return for the
government’s expenditures, the benefits are difficult to identify.
7.4.56 Large expenditures in programmes of such nature should be a high priority
for the auditor to examine.
7.4.57 Another aspect of risk relating to programme performance is the risk that
adverse publicity can arise. The danger of criticism of a programme can be
out of proportion with the potential or actual loss occurring due to some
weakness in the administration of the programme. There is often a trade-off
between the economic and efficient management of a programme and the
cautious avoidance or mistakes that can lead to embarrassment. The auditor
should be sensitive to this and be able to judge what are appropriate levels
of control.
7.4.58
Regulatory risk. One means of implementing government policy is through
regulatory activities. The usual purpose of regulations is to protect the
public – whether this is health protection, ensuring fair trade practices,
transportation safety, or other law enforcement.
7.4.59 Failures in a government’s regulatory programme can occur at various
points within the regulatory system. For example, regulatory risk can derive
from:
a) inadequate laws;
b) inadequate inspection/detection (insufficient resources available;
untrained inspectors; poor supervision of the inspectors);
c) inadequate penalties or other deterrents;
d) poor records and inadequate statistics; and/or
e) environmental factors outside of the regulatory process that impact on the
effectiveness of the regulatory programme.
7.4.60 The impact of regulatory weaknesses on government operations can be
significant, although not as obvious as misappropriations of funds, waste or
loss of monies. For example, the non-collection of taxes can represent a
huge loss to the government. Therefore the auditor must focus on
regulatory activities just as much as on expenditures.
7.4.61
Risk of fraud. There are many classical indicators of weaknesses that can
contribute to fraud. Some of these are:
a) Insufficient separation of duties;
b) Only one person with access to financial information, particularly if this
person exhibits defensive or guarded behaviour;
c) Weak controls;
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d) Inadequate management supervision, inspection, challenge or review;
e) Inadequate or untimely reports; and,
f) Late or non-existent reconciliations.
7.4.62 It is often beneficial to provide all auditors with some training in fraud
awareness and investigation, and to provide extensive Forensic Audit
training to one or a few auditors. Then one of those who have had extensive
training and experience can be consulted wherever any serious case of fraud
has been identified or is suspected.
Factors Affecting Audit Risk
7.4.63 To determine how much risk the auditor should accept that an unqualified
opinion may be issued on financial statements that are materially misstated,
the auditor would consider such matters as professional exposure, reporting
considerations and ease of audit.
Professional Exposure
7.4.64 This is the risk of loss or injury to the auditor's reputation from litigation,
adverse publicity or other events arising in connection with the financial
statements reported upon.
7.4.65 Professional exposure risk is often considered to be highest when there is a
good chance that the financial statements and the audit report thereon will
undergo a lot of scrutiny. This could occur in special situations such as
when an entity is:
a) Receiving a lot of bad publicity for an authority violation or other matter;
b) Being privatised, transferred to another level of government, or turned into
a special operating agency;
c) Issuing new debt; and/or
d) Getting into financial difficulty.
7.4.66 For audit entities such as these, the auditor may elect to reduce their audit
risk to reduce their professional exposure risk.
Reporting Considerations
7.4.67 These considerations usually include the number of users and the extent to
which they rely on the entity's financial statements and audit report.
Ease of Auditing
7.4.68 Factors to be considered here could include the practical availability of
audit evidence and the existence of an audit trail.
Determining Audit Risk
7.4.69 Even though the determination of audit risk is the auditor's responsibility
and not the financial statement users, it may be prudent to discuss the
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factors affecting audit risk and the assessed level directly with the users.
There are several reasons for this:
a) One of the factors affecting the required level of audit risk is the extent to
which the users rely on the entity's financial statements and audit report. If
the users are placing extensive reliance on the financial statements, the
auditor may wish to use a lower level of audit risk (i.e., obtain a higher
level of overall assurance) than if the users are placing very little reliance
on the financial statements. Discussing the level of audit risk with the users
will provide the auditor with direct evidence with respect to this factor.
b) Some of the users, such as government planners and managers as well as
legislators, may be aware of special circumstances that could increase the
auditor’s professional exposure risk. These may include circumstances of
which the auditor is not aware.
7.4.70
Guidelines: As for materiality, the assessment of audit risk is a subjective
process requiring the use of professional judgment. While guidelines should
not replace the use of professional judgment, the following may be useful:
Situation Audit Risk Overall
Assurance
Entities perceived to be high risk (and therefore
the auditor wants to achieve a high level of
overall assurance and set a low level of audit
risk)
3 97
All other entities 5 95
7.4.71 The Standard Audit Working Paper Kit contains a form that can be used to
assess audit risk.
7.4.72 As is evident from the above guidelines, the lower the audit risk being
taken, the more the assurance that is required. This is because audit risk and
overall assurance are converses of each other. Reducing audit risk from 5%
to 3% increases the desired level of overall assurance from 95% to 97%.
7.4.73 Increasing the overall assurance will increase the required amount of audit
work. Going from 95% assurance to 97% assurance could, for example, add
20% to the total required amount of audit work.
Auditor’s Responsibility to Detect Error and Fraud
7.4.74 Because the auditor designs audit procedures to detect errors in the
financial statements that in total exceed the selected level of materiality, an
audit most likely will not detect all immaterial errors. In fact, because the
auditor is providing
reasonable and not absolute assurance, there is a
chance that an audit performed in accordance with GAAS will fail to detect
some
material errors. Some of these errors may be due to fraud.
7.4.75 Fraud is the intentional act by one or more individuals to deceive others.
For example, an employee may steal cash and cover up the theft by
recording fictitious expenditures. Or the employee may not record an
The auditor is
providing reasonable
and not absolute
assurance.
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Audit Manual – Chapter 7
expenditure that would cause the ministry to exceed its allowable
expenditures.
7.4.76 The most difficult type of fraud to detect is fraud committed by
management. This is because management may be able to override internal
controls.
7.4.77 Not all frauds will result in errors in the financial statements. For example,
under the accounting principles contained in the New Accounting Model
(NAM), consumable stocks are not recorded in the financial statements.
Therefore, the theft of inventory would not affect financial statements
prepared using NAM.
7.4.78 When planning an audit, auditors normally start by assuming good faith on
the part of management, meaning that management officials are honest and
have done their best to ensure that the financial statements do not contain
any errors.
7.4.79 However, the assumption of management’s good faith cannot be blind faith.
As noted in paragraph 3.0.3 of DAGP’s auditing standards,
“The auditor
should design audit steps and procedures to provide reasonable assurance
of detecting errors, irregularities, and illegal acts that could have a direct
and material effect on the financial statement amounts or the results of
regularity audits. The auditor also should be aware of the possibility of
illegal acts that could have an indirect and material effect on the financial
statements or results of regularity audits.”
7.4.80 While the auditor is not required to actively seek out evidence of lack of
good faith by management, the auditor complies with the above standard by
planning and performing the audit with an attitude of professional
scepticism. This means that the auditor uses a questioning mind and keeps
alert for evidence that brings into question the reliability of documents or
management’s representations. Should evidence come to light that indicates
fraud may have occurred or the assumption of management’s good faith is
not appropriate, the auditor should design specific audit procedures to deal
with the matter.
7.4.81 Analytical procedures are a good technique to identify areas where further
investigations are required. These procedures are discussed in Section 7.8
below.
7.4.82 Procedures to investigate possible fraud normally include a detailed review
of specific projects, disbursements, etc. in which the fraud could have
occurred. Sampling would normally
not be used to detect or investigate
fraud, because it involves selecting a representative sample, as opposed to
zeroing in on the specific areas where further investigation is required.
The assumption of
management’s good
faith cannot be
blind faith.
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7-19
7.5 Step 4 – Understand the Entity’s Internal Control
Structure
Definition and Concepts of Internal Control
7.5.1 INTOSAI defines the internal control structure as the plans and actions of
an organisation, including management's attitude, methods, procedures, and
other measures that provide reasonable assurance that the following general
objectives are achieved:
a) Assets are safeguarded against loss due to waste, abuse, mismanagement,
errors, and fraud and other irregularities;
b) Laws, regulations, and management directives are complied with; and
c) Reliable financial and management data are developed, maintained and
fairly disclosed in timely reports.
7.5.2 The internal control structure of an audit entity is therefore very important
to the auditor.
7.5.3 Furthermore, an understanding of internal controls, and the weaknesses in
internal controls, is often critical for the auditor to make recommendations
for improvements. If the audit focuses only on individual transactions, the
auditor can only conclude, when errors are observed, that these errors
should be corrected. By examining the controls over these transactions, the
auditor can identify the reasons that the errors occurred. Then the auditor
can recommend that the weaknesses in the controls be corrected.
7.5.4 Hence, it is critical that the auditor examines
controls not just transactions.
General Standards for an Internal Control Structure
7.5.5 INTOSAI describes five general standards that entity management and
employees should follow:
a) Reasonable assurance. Internal control structures are to provide reasonable
assurance that the general objectives of the entity will be accomplished.
b) Supportive attitude. Managers and employees are to maintain and
demonstrate a positive and supportive attitude toward internal controls at all
times.
c) Integrity and competence. Managers and employees are to have personal
and professional integrity and are to maintain a level of competence that
allows them to understand the importance of developing, implementing and
maintaining good internal controls, and to accomplish the general
objectives noted in paragraph 7.4.1.
d) Control objectives. Specific control objectives are to be identified or
developed for each activity of the organisation and are to be appropriate,
comprehensive, reasonable, and integrated into the overall organisational
objectives.
An understating of
internal controls,
and the weakness in
internal controls, is
critical for the
auditor to make
recommendations for
improvements.
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Audit Manual – Chapter 7
e) Monitoring controls. Managers are to continually monitor their operations
and take prompt, responsive action on all findings of irregular,
uneconomical, inefficient, and ineffective operations.
Detailed Standards for an Internal Control Structure
7.5.6 In addition, INTOSAI describes six detailed standards that entity
management and employees should follow:
a) Documentation. The internal control structure and all transactions and
significant events are to be clearly documented, and the documentation is to
be readily available for examination.
b) Prompt and proper recording of transactions and events. Transactions and
significant events are to be promptly recorded and properly classified.
c) Authorisation and execution of transactions and events. Transactions and
significant events are authorised and executed only by persons acting within
the scope of their authority.
d) Separation of duties. Key duties and responsibilities in authorising,
processing, recording, and reviewing transactions and events should be
separated among individuals.
e) Supervision. Competent supervision is to be provided to ensure that internal
control objectives are achieved.
f) Access to and accountability for resources and records. Access to resources
and records is to be limited to authorised individuals who are accountable
for their custody or use. To ensure accountability, the resources are to be
periodically compared with the recorded amounts to determine whether the
two agree. The asset's vulnerability should determine the frequency of the
comparison.
7.5.7 The extent to which these standards can be met depends to some degree on
the nature of the entity. Small organisations are not always in a position to
maintain comprehensive separation of duties. The auditor should take such
matters into account when assessing the sufficiency of the internal control
structure.
Responsibility for Maintaining Internal Controls
7.5.8 Entity management is responsible for ensuring that a proper internal control
structure is instituted, reviewed, and updated to keep it effective.
7.5.9 It is then the responsibility of everyone in the entity to ensure that the
internal control structure functions as it should.
Entity management
is responsible for a
proper internal
control structure.
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7-21
7.5.10 In addition, the Controller General of Accounts has some responsibility for
maintaining an environment which promotes adequate internal control.
Section 5(d) of the Controller General Ordinance states that one of the
functions of the Controller General shall be “to lay down the principles
governing the internal financial control for Government departments in
consultation with the Ministry of Finance and the Provincial Finance
departments as the case may be”.
The Elements of Control
7.5.11 There are five basic elements that make up a control structure:
a) Control environment;
b) Risk assessment;
c) Control activities;
d) Information and communication; and
e) Monitoring.
7.5.12
Control environment. The control environment sets the tone for an
organisation, influencing the control consciousness of the staff. It relates to:
a) Management’s philosophy and operating style, including the specific way
in which staff are supervised and controlled;
b) The organisation structure;
c) Methods of assigning authority and responsibility;
d) Human resource policies and practices;
e) Management’s and staff’s integrity and ethical values;
f) Management’s and staff’s commitment to competence;
g) Management’s reaction to change and outside influences; and
h) Existence of an internal audit unit.
7.5.13
Risk assessment. Risk assessment is the identification and analysis of
relevant risks to the achievement of objectives. Management needs to
identify these risks in order to know the areas in which the internal control
structure needs to be particularly strong. Conversely, risk assessment may
indicate areas where risks are low, and therefore where the entity does not
need to design elaborate internal control structures.
7.5.14
Control activities. Control activities are the policies and procedures that
help ensure management directives are carried out. They help ensure that
necessary actions are taken to address the identified risks.
7.5.15 Control activities occur throughout the organisation, at all levels and in all
functions. They include a range of activities such as:
a) Proper authorisation of transactions and activities;
b) Physical control over assets and records;
c) Independent checks on performance; and
d) Adequate segregation of duties.
Risk assessment is
the identification
and analysis of risks
to the achievement
of objectives. In
order to know the
areas in which the
internal control
structure needs to be
particularly strong.
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Audit Manual – Chapter 7
7.5.16
Information and communication. Pertinent information must be identified,
captured and communicated in a form that enables people to carry out their
responsibilities.
7.5.17 To have pertinent information for accounting purposes, the entity needs to
have adequate documents and records. It also needs to have prompt and
proper recording of transactions and activities. This, in turn, requires a good
accounting system, and a good system of communication within the
organisation and with customers, suppliers, and other government entities.
7.5.18
Monitoring. Monitoring by management involves the ongoing and periodic
assessment of internal control performance to determine if controls are
operating as intended, and are modified when needed. Summary
information should be monitored and spot checks made on the quality and
timeliness of the information on selected transactions.
The Role of Internal Audit
7.5.19 Internal audit is in itself an internal control. It acts as an independent check
on performance. It can be very effective in helping management fulfil its
monitoring role.
7.5.20 To be most effective, internal audit must not become part of the operational
controls. The internal audit unit should not be performing checks on an
ongoing basis. It should audit and review after the fact, or as a separate,
independent and additional check, to ensure that the management and staff
have been carrying out their duties properly.
Categories of Controls
7.5.21 Controls can take different forms and serve different purposes. Different
ways of categorising controls are:
a) Input vs. output;
b) Independent vs. interrelated;
c) Manual vs. electronic;
d) General vs. application;
e) Documented vs. undocumented;
f) Preventive vs. detective; and
g) Compensating.
Input vs. Output
7.5.22 Input controls are controls over the initial input of data. They include
password controls to prevent unauthorised personnel from inputting
transactions. Output controls are controls over the output from systems.
They include comparing cheques (output of payment system) to supplier
invoices and other supporting documentation, and reviewing printouts of
cash disbursements to ensure that all pre-numbered cheques have been
recorded.
Internal audit is an
internal control.
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7-23
Independent vs. Interrelated
7.5.23 A control may work on its own or may need to be part of a series of
controls. For example, a reconciliation may be a powerful control in its own
right, but an input control will really only be effective if the entity also has
adequate controls over data processing and output.
Manual vs. Electronic
7.5.24 Manual controls, given the fact that they are operated by staff, can be
affected by human errors of judgment, misinterpretation, carelessness,
fatigue, and distractions.
7.5.25 In contrast, electronic controls are built into computer programmes and,
assuming that the systems are properly designed, installed and tested, are
inherently more reliable. Any problems with the software, however, might
be difficult to detect and often expensive to correct.
General vs. Application
7.5.26 General controls are applicable to the accounting system as a whole, such
as passwords restricting access to a computer network. Application controls
relate specifically to a particular processing function to ensure transactions
are authorised, complete and accurate.
Documented vs. Undocumented
7.5.27 Documented controls result in evidence that the control has been performed
(e.g., signatures and initials). Undocumented controls are controls where
there is no evidence that the control has been performed. These would
include, for example, many electronic controls where there is no evidence
that the appropriate person approved the transaction. The existence of these
controls can often be established through observation, inquiry and
testing/replication.
7.5.28 Another example is when management and staff of an entity follow sound
control principles based on experience. Sound controls may be in place but
not documented. This presents a control exposure since the control
procedures may be lost when staff turnover occurs.
Preventive vs. Detective
7.5.29 Preventive controls prevent errors from occurring. Most data entry controls
are preventive controls. In contrast, detective controls detect errors that
have occurred. Most output controls and reconciliation controls are
detective controls.
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Audit Manual – Chapter 7
7.5.30 Preventive controls are usually less costly to use than detective controls. It
is generally less costly to prevent an error than it is to detect and correct it
after the fact. It is possible, however, to find systems that are so strict in
preventing errors that a lot of valid data can be rejected because of minor
errors or missing data elements. This can cause serious delays and expense
in processing data.
Compensating Controls
7.5.31 These are controls that detect errors that occur at earlier control points.
7.5.32 As a general rule, a control over output can act as a compensating control
for a weak input control. For example, a control to review the list of cash
disbursements to ensure that there are no missing cheque numbers can
compensate for a weak control over the input of the disbursements.
Similarly, if a cheque is recorded for an incorrect amount, the error will
show up when the organisation performs the bank reconciliation. (This
assumes that the cheque has been cleared).
Limitations of Internal Control Structures
7.5.33 Internal control can help an entity to:
a) achieve its objectives;
b) comply with laws and regulations;
c) ensure reliable financial reporting; and
d) prevent loss of resources.
7.5.34 No matter how well conceived and operated, an internal control structure
can only provide reasonable – not absolute – assurance to management
regarding the achievement of its objectives, etc. There are limitations
inherent in all internal control structures. These include the realities that
judgments in decision-making can be faulty, and that breakdowns can occur
because of simple errors or mistakes.
7.5.35 Additionally, controls can be circumvented by the collusion of two or more
people, and management has the ability to override the system. In addition,
the design of an internal control structure must reflect the fact that there are
resource constraints, and the benefits of controls must be considered
relative to their costs.
Multiple Sub-Entities and Locations
7.5.36 In the case of government-wide audits there will be multiple ministries,
departments, etc. making up the reporting entity. Each of these may have
multiple locations.
7.5.37 There is no requirement for the auditor to take the same approach with
respect to each ministry and so on. The auditor may decide to place no
reliance on the internal control structure at some Drawing and Disbursing
An internal control
structure can only
provide reasonable
assurance.
Audit Manual – Chapter 7
7-25
Offices, but place a lot of reliance on some specific controls at the District
Accounts Offices. In this case:
a) For the DDOs, the auditor would only need an overview level
understanding of controls and a general understanding of the systems to
collect, record and process data and report on the results.
b) For the District Accounts Offices, the auditor would need a more detailed
understanding of the control environment and systems, to justify placing
reliance on them.
7.5.38 In terms of level of effort, the auditor should already have a good
understanding of the internal control structure through prior compliance
with authority work. Where a given sub-entity is small compared to the
materiality amount, a deep level of understanding is not required.
Understanding and Examining Internal Controls
7.5.39 The auditor is expected to review the internal controls as part of the audit.
7.5.40 First, the auditor should review and document the systems and procedures
in place to carry out the transactions and other activities of the operations.
Normally, a description of the major systems and procedures should be
maintained on the permanent audit file. In which case, the auditor should
review the description of the system and identify whether there have been
any changes to the system.
7.5.41 Next, the auditor should identify points in the accounting system, and in
other systems being audited, where he/she would expect to find controls.
7.5.42 Then the auditor should identify and document the controls at these points
and determine that the controls have been operating.
7.5.43 Finally, the auditor should assess the adequacy of the controls and conclude
whether any controls are missing or ineffective. The auditor should make
recommendations to management where, in the opinion of the auditor, the
controls should be strengthened. These recommendations should be based
on an appreciation of the risk of reduced performance, loss, damage or
waste compared to the additional costs, if any, of implementing improved
controls.
7.5.44 A Control Environment Worksheet is provided in the Standard Audit
Working Paper Kit.
The auditor is
expected to review
the internal control
as part of the audit.
Assess the adequacy
of the controls and
conclude whether
any controls are
missing or
ineffective.
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Documenting Our Understanding of Controls
7.5.45 The auditor should document the internal controls as part of the audit. A
clearly documented description of the controls enhances the auditor’s
ability to assess the controls. Also, the documentation aids supervision of
the audit and improves communications between members of the team. The
documentation should form part of the working papers and should be
included on the permanent file.
7.5.46 Methods of understanding the system and application of controls include:
a) Narrative;
b) Flowchart;
c) Internal Control Questionnaire (ICQ); and
d) Walk-through.
7.5.47
Narrative. This is a written description of an entity’s internal controls.
Narrative of an accounting system and related controls includes four
characteristics:
a) Information on the origin of every document and record in the system;
b) Description of all processing that takes place;
c) The disposition of every document and record in the system; and
d) An indication of the controls relevant to the assessment of control risk -
these typically include separation of duties, authorisation and approvals
and internal verification.
7.5.48
Flowchart. This is a time-consuming exercise and is generally applied only
when the effort can be justified, such as when there is some uncertainty
about the processes or the complexity and importance of the procedures
indicate a need for clear representation.
7.5.49 The flowchart is a diagrammatic representation of the entity’s documents
and their sequential flow in the organisation and can be a valuable
component of the working paper file. It includes the same four
characteristics identified above for narratives.
7.5.50 The advantages of a flowchart are that it:
a) provides a concise overview of the entity’s system;
b) helps identify inadequacies by showing how the system operates;
c) shows clearly the separation of duties allowing the auditor to judge
whether they are adequate; and
d) is easier to follow a diagram than to read a description.
7.5.51
Internal Control Questionnaire. The ICQ is a common tool of the auditor.
It contains a series of questions about the controls in each audit area. There
is usually a pre-developed ICQ that may, or may not be tailored for the
particular area under examination by the auditor. It is designed to require a
The auditor should
document the
internal controls as
part of the audit.
The ICQ contains a
series of questions
about the controls in
each audit area.
Audit Manual – Chapter 7
7-27
“yes” or a “no” response, with a “no” response indicating potential internal
control deficiencies.
7.5.52 The advantage of using the ICQ is it allows the auditor to thoroughly cover
each audit area reasonably quickly at the beginning of the audit.
7.5.53 The disadvantages are:
a) The individual parts of the entity’s systems are examined without
providing an overall view;
b) A standard questionnaire may not apply to all audit entities; and
c) There is a danger of taking a mechanical approach rather than thinking
through the control needs of the particular operations under
examination.
7.5.54
Walk-Through (Cradle to Grave Test). The walk-through is conducted to
confirm that the system and controls are operating in accordance with the
auditor’s understanding. It is used to verify that identified controls have
been put into operation.
7.5.55 To conduct a walk through test the auditor selects a few transactions
(generally between 3 and 6), pertaining to each significant transaction
cycle, and traces them through the cycle beginning with initiation of the
transaction, through processing until it is ultimately summarised and
included in a general ledger or management report.
7.5.56 The auditor should document the transactions selected for walk-through, the
controls that were observed and describe any enquiries made of client
personnel.
7.6 Step 5 – Determine Components
Definition
7.6.1 Auditors normally do not plan audits for the financial statements as a
whole. Rather, they divide the financial statements into parts and plan each
part separately.
7.6.2 A component is a discrete item in the financial statements.
7.6.3 How to determine the components to be used
7.6.4 For a financial statement audit, the most logical way of dividing up the
financial statements is to consider each line item in the financial statements
to be a separate component.
7.6.5 “Line items” are each of the amounts reported in the financial statements,
including amounts disclosed in the notes thereto.
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Audit Manual – Chapter 7
7.6.6 Sometimes the financial statements include several different groupings of
the same total amount. For example, expenditures may be grouped by:
a) the ministries, departments, agencies, etc. making up the reporting entity;
b) appropriation account;
c) economic function (general public services, defence affairs and services,
etc.); or
d) object element (payroll expenditures, operating expenditures, civil works,
etc.).
7.6.7 The auditor selects the grouping that makes it the easiest to plan, perform
and evaluate the audit work. The auditor would then need to perform
additional procedures to ensure that the amounts reported in the other
groupings are also presented fairly.
7.6.8 To illustrate, assume that the financial statements group expenditures by
both
ministry and by object element. In this case, the auditor could either
plan the audit of expenditures using each ministry as a component, or using
each object element as a component. If the auditor chooses “object
element”, the auditor would then plan the audit to obtain reasonable
assurance that payroll expenditures are not materially misstated, that
operating expenditures are not materially misstated, etc. The auditor would
then develop additional audit procedures to ensure that the total
expenditures reported for each ministry are also not materially misstated.
7.6.9 For financial certification audits, it is unlikely that the financial statements
will contain details with respect to expenditures, etc. by district accounts
officer or by drawing and disbursing officer. However, DAGP may wish to
extend the audit to include these organisational units as components to be
reviewed, based on DAGP’s assessment of their risk or significance.
7.6.10 For compliance audits, it might be decided that individual DAOs or DDOs
should be subject to review. This is at DAGP’s discretion and will be
reflected in the individual audit plans.
Individually Significant Transactions and Events
7.6.11 Individual significant transactions and events include:
a) Very large transactions and events; and
b) High risk transactions and events.
7.6.12 The auditor should audit 100% of these transactions and events.
7.6.13 Very large transactions and events are usually audited 100% because they
are large enough that, should they be in error, the error could be significant.
The auditor therefore does not want to risk failing to find an error in these
transactions and events.
7.6.14 High risk transactions and events are transactions and events that, because
of their nature, contain a high risk of being in error. They are often audited
100% because, while the error in each one of these transactions and events
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7-29
may not be significant, the high likely error rate in these transactions and
events could result in a significant error in total.
7.6.15 Very large transactions are normally easy to find – the auditor should look
for transactions and events exceeding a pre-determined amount.
7.6.16 High risk transactions can be more difficult to detect. The auditor should
use his/her knowledge of the entity’s business to identify these transactions
and events.
7.6.17 These transactions and events are normally not treated as separate
components. Rather, they are audited as part of the work performed on
other components. However, there may be some cases where it is
advantageous to consider them to be a separate component. This could
occur when the inherent risk or control risk associated with these
transactions are significantly different from the risks associated with the
other transactions contained in the component.
Using Sub-Components
7.6.18 There may be cases where the inherent risk and control risk for part of a
component are significantly different than for the rest of a component. In
these cases, the auditor may decide to split the component into subcomponents
– the one(s) with the higher risks and the rest of the
component. Higher-risk sub-components will receive a higher level of
audit examination than lower risk ones.
7.6.19 Should the inherent risks or control risks for a particular DAO be
significantly higher than for other DAOs, and if the amounts involved are
substantial, the auditor should consider breaking out the single high risk
office and planning its audit separately.
Related Components and Transaction Cycles
7.6.20 Some components are related to other components. For example, an
understatement of expenditures may also result in an understatement of
liabilities and/or an overstatement of cash. Therefore, the audit of each of
these components will provide the auditor with some assurance as to the
fairness of the related components. To avoid doing more work than
necessary, the auditor should take the assurance achieved from auditing the
related components into account.
7.6.21 One way to do this is to consider transaction cycles – the flow of the
transactions. For example, the purchase of a medical supply will result in a
stock item that will either be in expenses for the year or in the year-end
stock balance. The purchase will also result in a cash disbursement or a
payable at year end.
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7.6.22 The internal control questionnaire and audit programmes contained in the
Standard Audit Working Paper Kit and Audit Guides contain the “standard”
components for the entities being covered, and use a transaction cycle
approach for the tests of internal control. It must be stressed that the auditor
needs to assess inherent risk and control risk for each component and
specific financial audit or compliance with authority objective, as opposed
to each transaction cycle and specific financial/compliance audit objective.
7.7 Step 6 – Determine financial audit and compliance
with authority objectives, and error/irregularity
conditions
Specific Financial Audit Objectives
7.7.1 Having divided the audit into components, the next step is to define what
we mean by “properly presents” in the audit certificate. To do so, the
auditor needs to consider what he/she would consider to be an error.
7.7.2 For a financial statement audit, a component is considered to be in error if:
a) it is not valid (the asset or liability does not exist or the revenue or
expenditure has not occurred
b) the asset, liability, revenue or expenditure is not complete;
c) the transactions have not been carried out in proper compliance with
relevant laws, regulations and administrative rules;
d) the asset or liability is not properly valued or is misclassified, or the
revenue or expenditure is not properly measured or is misclassified; or
e) the financial statement presentation is not proper.
7.7.3 The Standard Audit Working Paper Kit and Audit Guides make use of these
specific financial audit objectives.
7.7.4 To illustrate, payroll expenditures may be materially misstated if:
a) the costs are not valid. This could be due to, among other things, ghost
workers on the payroll.
b) the costs are not complete. For example, employees have not been paid, or
the payments have not been recorded.
c) the costs are not properly measured. This could be due to paying employees
more or less than they should be paid, or the amounts being recorded being
more or less than the actual payments.
d) the financial statement presentation is not proper. This could be due to the
failure to disclose all of the information called for in the New Accounting
Model.
Related Compliance with Authority Objectives
7.7.5 Reviewing compliance with laws and regulations is very important.
Decision makers need to know if the laws and regulations are being
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followed, whether they are having the desired results and, if not, what
revisions are necessary.
7.7.6 Section 3.4 of DAGP’s auditing standards states, “In conducting [financial]
audits, a test should be made of compliance with applicable laws and
regulations.”
7.7.7 To comply with this standard, the auditor need not test for compliance with
all
laws, regulations, rules, policies, etc. As noted in paragraph 3.4.3 of
DAGP’s auditing standards,
“Because the laws and regulations that may
apply to a specific audit are often numerous, the auditors need to exercise
professional judgement in determining those laws and regulations that
might have a significant impact on the audit objectives.”
7.7.8 For financial audits, Section 3.4 of DAGP’s auditing standards requires the
auditor to “design audit steps and procedures to detect errors, irregularities,
and illegal acts that could have a direct and material effect on the financial
statement amounts or the results of regularity audits. The auditor also
should be aware of the possibility of illegal acts that could have an indirect
and material effect on the financial statements or results of regularity
audits.”
7.7.9 In deciding which laws and regulations should be examined as part of a
financial audit, the auditor should deal with those laws and regulations that
might have a significant impact on the financial audit objectives.
7.7.10 In addition to compliance audit work performed as part of a financial audit,
DAGP also conducts extensive compliance tests to identify deviations and
validate controls at organisational units across the Government of Pakistan.
7.7.11 Departments, ministries, etc. are not permitted to spend, borrow or raise
revenue without the approval of Parliament. Therefore, audits of
compliance with authority should focus on compliance with authority to
spend, borrow and raise revenue, as follows:
Spend
7.7.12 Determine that:
a) the services were actually performed or the goods were actually
received;
b) the expenditure is consistent with the nature of the appropriation to
which it was charged;
c) the expenditure does not result in the total approved expenditure being
exceeded; and
d) the expenditure is in accordance with the applicable legislation and the
rules and regulations issued by such legislation have been complied
with.
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Borrow
7.7.13 Determine that the amount and debt terms (period, interest rates, repayment
schedule, etc.) are in accordance with the appropriate law.
Raise revenue
7.7.14 Determine that the cash received is:
a) for an approved tax or other approved revenue source; and
b) is received in accordance with the applicable legislation and the rules
and regulations issued by such legislation have been complied with.
7.7.15 The compliance with the authorities tests noted above apply to
organisational, functional or accounting units for different types of
government body as follows:
7.7.16
Federal and provincial governments. All the authorities described in the
preceding section would usually be considered part of the audit of federal
and provincial governments.
7.7.17
District governments. District governments are not permitted to borrow.
Therefore only authorities to spend and to raise revenues would normally
be considered part of the audit of a district.
7.7.18
State-owned enterprises. These enterprises are usually created by separate
acts. These acts and the supporting regulations usually specify the
operations that the enterprise is permitted to carry out. Compliance with the
spending, borrowing and revenue-raising authorities in these acts and
regulations is therefore usually the principal focus of the compliance with
authority work for these audits.
Potential Error Conditions
7.7.19 The last part to this step is to consider error conditions. The idea here is to
consider ways in which an asset, liability, revenue or expenditure item
might not be valid, might not be complete, etc. Put another way, the
auditor’s objective is to identify ways in which a monetary error can occur
in the financial statements, or an applicable authority may not be complied
with.
7.7.20 There are probably numerous reasons why a component might not be valid,
might not be complete, etc. However the chance of some of them occurring
might be negligible. Similarly, the maximum possible error that could result
from some of them might be insignificant. The auditor’s objective is to
identify the errors that have a real chance of occurring, and that could be
relatively large in relation to the materiality amount. For this reason, error
conditions are sometimes referred to as “potentially big errors”.
7.7.21 Note that conditions that constitute an error will be affected by the
accounting policies being used. For example, if the accounting policies do
not call for the recording of accounts payable, then the failure to record a
Error conditions are
ways in which an
asset, liability
revenue or
expenditure item
may not be valid
complete, etc.
Audit Manual – Chapter 7
7-33
payable would not constitute an error. However, there should be a system
to track unsettled payables in the form of commitments against
appropriations.
7.7.22 The process of determining which error conditions or compliance
deviations should be audited will help to ensure that the audit plan is
complete. The process will also help to ensure that the audit plan does not
include unnecessary work. The process therefore helps to ensure that
auditors spend their time dealing with matters of real importance, and do
not waste their time on insignificant matters.
7.7.23 For example, consider the component “payroll expenditures”.
7.7.24 For the
completeness of payroll expenditures, the auditor considers how
payroll expenditure figures might not be complete and may identify the
following three error conditions:
a)Services performed have not been paid for;
b) Payments made have not been recorded in the payroll register; and
c)The amounts in the payroll register have not been included in the
financial statement amounts.
7.7.25 In addition, the auditor needs to consider whether there are any related
compliance with authority objectives. In this case, because compliance
objectives relate to controlling what has been spent, as opposed to ensuring
that the spending is complete, there are no related compliance objectives.
7.7.26 Consider the
validity and measurement objectives for payroll expenditure.
The auditor may identify four additional error conditions, as follows:
a) Services paid for were not performed (because, for example, there are ghost
workers on the payroll);
b) Employees have been paid more or less than they should be paid;
c) Payroll expenditures are recorded in the Payroll Register at the wrong
amount;
d) The payroll expenditures have been charged to an incorrect account or
appropriation; and
e) The amounts in the payroll register have not been included in the financial
statements at the correct amount.
7.7.27 In this case, the auditor may also identify the following
compliance with
authority
matters:
a) The work being performed was not properly approved;
b) Pay rates/employee levels were not properly approved in accordance with
regulations; and
c) The payments were not properly approved.
d) The same approach can be applied to receipts. For example, for the
completeness of income tax receipts, the auditor may identify three error
conditions, as follows:
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e) Income tax receipts are not deposited in the bank;
f) Income tax receipts are not recorded in the cash receipts register; and
g) The amounts in the cash receipts register are not included in the financial
statement amounts.
7.7.28 In addition, the auditor needs to consider whether there are any related
compliance with authority objectives
. In this case, there probably is one –
that the receipts were deposited within the time period required by
government policy.
7.7.29 For the
validity and measurement objectives for income tax receipts, the
auditor may identify three other error conditions, as follows:
a) The amount of the receipt does not match the amount required to be
remitted as per the income tax return;
b) The income tax receipts are being charged to an incorrect account; and
c) The amounts in the cash receipts register are not included in the financial
statements at the correct amount.
7.7.30 In addition, the auditor may also identify one
compliance with authority
matter – the government did not remit any overpayments by the taxpayer
back to the taxpayer on a timely basis.
How Error Conditions and Compliance Irregularities are Used to Develop
Audit Programmes
7.7.31 The error conditions/compliance deviations provide the auditor with
guidance as to which audit procedures should be included in the audit
programme. Using the errors/irregularities identified above, for regularity
and measurement of payroll expenditures for example, the auditor can
develop audit procedures to determine if:
a) Services paid for were actually performed;
b) Employees were paid correct amounts;
c) Payments are being recorded in the payroll register at the correct amount
d) Payments are recorded in the correct account and appropriation at the
correct amount;
e) Amounts in the payroll register are included in the financial statements at
the correct amount;
f) The work performed was properly approved; and
g) Payments made were properly approved.
7.7.32 Similarly for the regularity and measurement of income tax receipts the
auditor could develop procedures to determine if:
a) The amount received matches the amount due;
b) Receipts are posted to the correct account;
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7-35
c) Amounts in cash receipts register are included in the financial statements at
the correct amount; and
d) Government is remitting overpayments back to taxpayers on a timely basis.
7.8 Step 7 – Assess inherent risk and control risk
7.8.1 Inherent risk and control risk may differ by component and
audit/compliance objective. As a result, the auditor may have a large
number of different inherent and control risk valuations to deal with.
7.8.2 It is tempting to combine different risks by using a weighted approach.
However, this approach is not generally recommended as it fails to meet the
standards for generally accepted auditing standards.
Inherent Risk
7.8.3 Inherent risk is the chance of material error occurring in the first place
assuming that there are no internal controls in place. “Material error” may
be one error or the sum of multiple smaller errors.
7.8.4 Inherent risk is evaluated at this stage to determine how much testing of
internal controls and substantive testing (analytical procedures and
substantive tests of details) the auditor needs to perform to achieve the
desired level of assurance. In general, the greater the inherent risk, the
greater the audit effort required.
7.8.5 Inherent risk is assessed assuming that there are no internal controls in
place. As such, it needs to be assessed in a hypothetical environment.
7.8.6 Factors affecting inherent risk include:
7.8.7
The nature of the component. Components such as cash are more
susceptible to manipulation or loss than, say, fixed assets.
7.8.8
The extent to which the items making up the component are similar in size
and composition.
If the population is composed of relatively homogeneous
items, it would be easier for management (and the auditor) to detect
anomalous transactions and amounts.
7.8.9
The volume of activity. If there are a lot of transactions being processed, the
chances of an error occurring may be higher than if only a few transactions
are being processed.
7.8.10
Competence of the staff processing the transactions. If staff are experienced
and take their jobs seriously, there is probably a lower inherent risk than if
they are inexperienced or careless.
Inherent risk is the
chance of material
error occurring
assuming there are
not internal
controls.
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Audit Manual – Chapter 7
7.8.11
The number of locations. Entities operating out of a single location with a
centralised accounting system may have a lower inherent risk than those
operating out of many locations, each with its own accounting system.
7.8.12
The accounting policies being used. Many components have a lower risk of
error when the cash basis of accounting is being used than when the accrual
basis of accounting is being used.
7.8.13
Factors that could affect the risk of fraud. An error could be an intentional
one. The auditor should use a questioning mind and be alert for evidence
that contradicts or brings into question the reliability of documents or
management’s representations.
7.8.14 It can be seen from the above that evaluation of inherent risk is based
primarily on the auditor’s knowledge of the entity and its environment. This
knowledge would have been acquired primarily in Step 2 of the process –
updating the understanding of the entity’s business.
7.8.15 The assessment of inherent risk will be subjective, and will require the use
of professional judgment. It would therefore be appropriate to have the
most experienced and knowledgeable individuals on the audit team make
the assessment of inherent risk. These should be the individuals with the
greatest knowledge of the entity being audited.
7.8.16 Inherent risk may differ by component and by specific financial audit
objective. For example, the risk of cash being improperly valued is low, but
the risk of cash not being complete may be quite high.
7.8.17 Inherent risk needs to be assessed throughout the audit. For example, if
inherent risk is assessed as “low” at the general planning phase but
numerous errors are found during the fieldwork phase, then the assessment
of inherent risk may need to be revised.
7.8.18 While guidelines should not replace the use of professional judgment, the
following may be useful when assessing inherent risk:
Level of Inherent Risk Risk
Resulting
Assurance
High inherent risk 60% 40%
Moderate inherent risk 50% 50%
Low inherent risk 40% 60%
7.8.19 Risk assessment is a matter for DAGP and will reflect ground realities
within the entity being audited. It is recommended that a conservative
approach be considered until DAGP gains experience with this
methodology, to recognise the danger of using an incorrectly low risk
factor. Assume the auditor sets inherent risk at a low 20%. At this level,
the auditor could eliminate all or most substantive sampling, and little work
would be required on the component. Given this low level of planned
effort, if there are significant monetary errors or compliance irregularities
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7-37
they are likely not to be detected, and in the worst case, the auditor might
issue an unqualified report when there were actually material errors present.
7.8.20 Accordingly, an inherent risk factor of not less than 40% is recommended
unless there is convincing evidence such as prior compliance with authority
audit work that detected a high level of compliance or few monetary errors.
7.8.21 The Standard Audit Working Paper Kit includes an Inherent Risk
Assessment Form that can be used to assess inherent risk.
Control Risk
7.8.22 Control risk is the chance that the entity’s internal controls will not prevent
or detect material error and is directly related to the effectiveness of the
internal control structure.
7.8.23 Control risk is evaluated at this stage as it limits the amount of assurance
that the auditor can obtain from tests of internal control.
7.8.24 Much of the work required to assess control risk would have been
performed as part of updating the understanding of the entity’s internal
control structure.
7.8.25 Control risk is also affected by the factors that could affect the risk of fraud
– particularly management fraud. This is because management can often
override the internal controls that have been put in place. As discussed
above, the auditor needs to use a questioning mind and keep alert for
evidence that contradicts or brings into question the reliability of
documents or management’s representations.
7.8.26 Control risk may differ by component and by specific audit objective and
related compliance with authority objective. For example, entity
management may have devised very good controls over the payment
process to ensure the validity and measurement of expenditures, but may
have paid less attention to the completeness of those expenditures.
7.8.27 In general, the control environment and the controls that collect, record,
process and report often have a pervasive effect on many components and
specific financial audit objectives and related compliance with authority
objectives. The controls that enhance reliability are the ones that are most
likely to differ by component and by specific audit objective.
7.8.28 Analytical procedures can be used as means of assessing the combination of
inherent risk and control risk.
7.8.29 Control risk needs to be assessed throughout the audit. For example, if
control risk is assessed as “low” at the general planning phase but
numerous internal control deviations (improperly approved supplier
invoices, for example) are found during the fieldwork phase, then the
assessment of control risk may need to be revised.
Control risk is the
chance that the
internal controls
will or prevent or
detect material error.
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7.8.30 While guidelines should not replace the use of professional judgment, the
following may be useful when assessing control risk:
Level of Control Risk Risk
Resulting
Assurance
High (poor internal controls) 80% Up to 20%
Moderate (moderate internal controls) 50% Up to 50%
Low (strong internal controls) 20% Up to 80%
7.8.31 The reason for presenting “Resulting Assurance” as an amount “up to” a
percentage limit is that, unlike inherent assurance, control assurance must
be earned. The auditor should not rely on the internal controls unless tests
demonstrate that the controls are working.
7.8.32 To illustrate, the auditor may have concluded that the internal controls over
the validity and measurement of payroll expenditures were moderate. The
auditor may therefore have assessed control risk as “moderate” (50%). This
means that, for this component and these specific financial audit objectives,
the auditor can place moderate reliance (50%) on the internal control
structure.
7.8.33 To place moderate reliance on the internal controls the auditor must do a
fair amount of testing of internal controls. The auditor may decide that it is
more efficient to place only limited reliance on the internal control structure
and instead do detailed analytical procedures and use a large sample for
substantive tests. In this case, even though the auditor may have been able
to obtain a control assurance of 50%, the auditor may decide to do only
enough tests of internal control to support a 20% level of assurance. The
auditor would then set control risk at 80%.
7.8.34 It has been noted that control risk is assessed at this stage as it limits the
amount of assurance the auditor can obtain from his/her tests of internal
control. Assume that, in the above illustration, the auditor wants to place a
lot of reliance on the internal control structure. Because control risk was
assessed at 50%, it is not possible for the auditor to obtain more than a
moderate level of assurance from the internal controls.
7.8.35 Put more simply, it is not possible to place a lot of reliance on a poor
internal control structure.
7.8.36 To provide some practical guidance, consider the following questions:
Question 1:
7.8.37 Should the control environment in all DDOs be documented, or should only
the controlling offices be taken into account?
Answer
:
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7.8.38 This answer refers back to a basic auditing concept – the auditor should
document and test any controls on which reliance is to be placed.
Therefore, any controls, in any DDOs, on which the auditor intends to rely
should be documented.
Question 2:
7.8.39 If the controls in one department are not reliable, should it affect the
auditors view of the overall control environment?
Answer:
7.8.40 If the controls in one department are not reliable, but in other departments
they are, the auditor can assess control risk as “high” where they are not
reliable, and “low” in the other departments. The auditor should not
attempt to come up with an aggregate risk assessment.
Question 3:
7.8.41 What would be the relative weightings of authorisation and accounting
controls? That is to say, how would the auditor’s assessment be affected if
the authorisation controls are working and the accounting controls fail more
often than not?
Answer
:
7.8.42 As for the response to Question 2, the auditor should not attempt to derive
an aggregate risk assessment. In this case, the auditor may decide to rely on
the authorisation controls, but cannot rely on the accounting controls.
7.8.43 Since the auditor would need to take a substantive approach with respect to
transactions flowing through the system because of the poor accounting
controls, relying on the authorisation controls would not likely reduce the
amount of the required substantive testing. Therefore, the most cost
effective approach would likely be to assess control risk for the particular
transaction cycle as high and audit accordingly.
Question 4:
7.8.44 What aggregation and consolidation mechanism should be used to develop
an overall assessment of the control environment prevailing in the Federal
Government.
Answer
:
7.8.45 Because the Federal Government is made up of many sub-entities, each of
which has its own risk profile, it is not appropriate to try to derive an
aggregate risk assessment. Separate control risk assessments are made for
each financial audit and compliance with authority audit objective for each
component, within each sub-entity.
Question 5:
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7.8.46 Suppose in all but two of the sub-offices of a ministry, controls can be
relied on, but they cannot be relied upon for the remaining two sub-offices.
Suppose also that the control environment in the DDOs is poor. How
should the auditor proceed?
Answer:
7.8.47 The auditor could assess control risk as “low” in all but the two sub-offices
and plan to rely on the related controls, while not relying on controls in the
“high” risk sub-offices. Since the control environment in the DDOs is
poor, the auditor may be forced to a substantive approach with respect to
the transactions flowing through the system. Relying on the controls in the
sub-offices may therefore not reduce the amount of required substantive
testing. If that is the case, the most cost effective approach would probably
be to assess control risk for the particular transaction cycle as high.
Question 6:
7.8.48 If the auditor does not aggregate the risk assessments of individual subentities,
components and objectives, won’t the auditor end up with
hundreds of different assessments of control risk? And won’t it take an
auditor considerable time to come up with all those different assessments?
Answer:
7.8.49 Theoretically, it is possible that the auditor will end up with hundreds of
different assessments of control risk. However, in practice this is not
generally the case and the auditor often winds up taking approximately the
same approach for many different components, specific financial audit
objectives and related compliance with authority objectives. There are
several reasons for this:
7.8.50 The control environment is generally a strong determinant of the
effectiveness of internal controls, and often applies quite widely across
components in each sub-entity. As a result, if it is possible to place a lot of
reliance on the internal controls for one component, it is normally possible
to place a lot of reliance on internal controls for many of the other
components in the same sub-entity.
7.8.51 Also, as noted previously, components may be inter-related. For example,
an understatement of cost of sales may also result in an overstatement of the
year-end stock balance and/or an understatement of the year-end accounts
payable balance and/or an overstatement of cash. One particular audit
procedure, such as testing the validity and measurement of cost of sales,
may also provide assurance as to the validity and valuation of the year-end
stock and accounts payable balances. It therefore often makes sense to use
approximately the same sources of assurance for these related components.
7.8.52 Regarding the amount of time required to perform multiple assessments, it
is true that the level of effort will be greatest when first assessing each
control risk. Once the various controls have been assessed, the auditor
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7-41
would only need to consider the impact of changes in the nature of the
entity, the results of the previous year’s audit, and so on, as opposed to
repeating the entire exercise from scratch.
7.8.53 Recognising the challenge of establishing initial risk assessments across
large audit entities, it is suggested that DAGP consider a phased approach
to risk assessments, and accepts that audits for the initial years will not
cover all aspects of risk assessment because of resource and time
constraints. This is not intended to provide a justification for weak
execution of audit procedures, but recognises that it may take a number of
audit cycles for rigorous audit procedures to be applied across all aspects of
each audit. It is suggested that DAGP strategic audit plans for the first few
years of implementing these new audit procedures should accommodate
this phased approach.
7.8.54 The Standard Audit Working Paper Kit contains a Control Risk Assessment
Form that can be used to assess control risk.
7.9 Step 8 – Determine mix of tests of internal controls,
analytical procedures and substantive tests of
details
Introduction
7.9.1 Financial audit procedures are usually broken down between tests of
internal control and substantive tests supplemented with compliance with
authority tests. DAGP also conducts audit activities which focus
exclusively on compliance with authority testing.
7.9.2 Tests of internal control are used to gain assurance that specific controls
within the entity’s internal control structure are operating effectively, and
are therefore helping to reduce the chance of material error existing in the
accounting information.
7.9.3 Substantive tests are procedures used to gain direct assurance as to the
completeness and accuracy of the data produced by the accounting systems.
They are often broken down between analytical procedures and substantive
tests of details.
7.9.4 Audit procedures that provide both assurance with respect to internal
controls and substantive assurance are often referred to as “dual purpose”
tests.
7.9.5 Compliance with authority procedures are used to determine whether entity
staff have fulfilled the administrative requirements of all applicable rules,
regulations and legislation.
Financial audit
procedures usually
include tests of
internal control and
substantive tests
supplemented with
compliance with
authority tests.
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Tests of Internal Control
7.9.6 Tests of internal control include:
a) Inquiries of appropriate entity personnel;
b) Observation of policies and procedures in use;
c) Walk-through procedures; and
d) Selecting a sample of transactions and verifying that the appropriate control
procedures were followed.
7.9.7 The first three procedures are the same as were used to update the
understanding of the internal control structure. The work done at that stage
will have already provided some assurance with respect to the internal
control structure.
7.9.8 With respect to sampling, if the auditor wishes to place high reliance on a
specific internal control, it is normally necessary to test the control
throughout the entire year. If, on the other hand, the auditor only wishes to
place moderate reliance on the control, it may be sufficient to select a
sample of transactions to an interim date (say, the first 8 months of the
year), and then to use inquiries, observations and walk-through procedures
to ensure that there have been no changes made to the internal control
structure between the interim date and the year-end date.
7.9.9 If the auditor only wishes to obtain limited reliance on a particular internal
control, then sampling is often not required at all –inquiries, observations
and walk-through procedures may provide all of the required assurance.
7.9.10 GAAS do not permit the auditor to obtain all of his/her assurance through
tests of internal control – some substantive testing must always be
performed. This is because the ability of the internal control structure to
prevent or detect material error is subject to practical limitations, such as:
a) Members of management may be in a position to override specific internal
controls.
b) Collusion can circumvent internal controls that depend on good segregation
of duties to be effective.
c) Inexperienced entity officials may not perform their control procedures
properly. There is always a possibility of human error.
d) Internal controls are often designed to address transactions arising from the
normal course of the entity’s activities. They may not cover transactions of
an unusual nature, or arising from new activities.
e) Management may not be prepared to devote the resources that would be
required to prevent or detect all errors. Rather, management normally
requires that the internal controls be cost-effective. This means that the
benefits of having the controls must exceed their costs.
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Analytical Procedures
7.9.11 Analytical procedures are techniques used by the auditor to:
a) Form expectations as to what the recorded amounts should be by studying
the relationships among elements of financial and non-financial
information;
b) Compare those expectations with the recorded amounts; and,
c) Draw conclusions about entity operations, inherent risk and control risk,
and the completeness and accuracy of the recorded amount.
7.9.12 Analytical procedures are an efficient and effective way to obtain audit
assurance. As a result, they should be performed on every audit.
7.9.13 Analytical procedures may be used in all phases of the audit to achieve
various objectives, for example:
7.9.14 Planning phase:
a) to obtain knowledge of the entity’s business operations;
b) to identify unusual items and explore areas of potential high inherent risk;
and
c) to obtain some degree of audit assurance.
7.9.15
Fieldwork phase: to obtain some degree of audit assurance.
7.9.16 Evaluation phase:
a) to assess the internal consistency and overall reasonableness of the financial
statements using the auditor's knowledge of the entity; and
b) to obtain some degree of audit assurance.
7.9.17 The auditor can derive various levels of assurance from analytical
procedures depending on how rigorously the analytical procedures are
designed and performed.
7.9.18 There are several different types of analytical procedures, as follows:
General reviews for reasonableness.
7.9.19 These analytical procedures involve a high level comparison of current
information with previous periods, budgets or statistics from the entity. No
pre-determined threshold amount is specified for identifying significant
fluctuations. The process is sometimes referred to as “eyeballing” the
financial statements – looking for accounts that appear to be unusual in
amount, in volume of activity, etc. The objective of this type of analysis is
generally to decide where to focus audit attention.
Comparative analysis.
“Eyeballing” the
financial statements.
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7.9.20 This involves comparing the current year's reported amounts (or ratios)
with those of the prior years. Comparative analysis assumes that the prior
year's amount is a sufficiently accurate estimate of the current year's
amount and, therefore, can be used to identify any significant fluctuations
from the current year's recorded amount. A pre-determined threshold
amount is specified for identifying significant fluctuations.
Predictive analysis.
7.9.21 Predictive analysis compares the current year's reported amounts (or ratios)
with a prediction of what the current year's amount (or ratio) should be,
based upon the trend of the prior years’ amounts (or ratios). The prior
years’ data used in making the prediction is adjusted for all known changes
in the factors affecting the data. This usually results in a more precise
estimate than comparative analysis. A pre-determined threshold amount is
specified for identifying significant fluctuations.
Statistical analysis.
7.9.22 This category of analytical procedures involves analysing the known
behaviour of variables and developing an equation (model) that explains the
relationship between these variables. Although this category is similar to
"predictive analysis", the distinguishing characteristics of statistical analysis
is that it uses more rigorous methods, such as regression analysis, to
provide more accurate predictions and objectively measures the confidence
level and the achieved level of precision.
Overall verification procedures.
7.9.23 This category of analytical procedures involves building up an estimate of
an account balance from known and verified data. For example, the auditor
could verify the number of rental units by type of unit, the average rent by
type of unit, and the vacancy rate. The auditor could then compare the
product to the revenue received from the rents. Overall verification
procedures usually result in an accurate estimate of the account. A predetermined
threshold amount is specified for identifying significant
fluctuations for the auditor to investigate.
7.9.24 Care is required with this type of analysis. The auditor must not assume
that the data are more accurate than the financial information. For example,
the actual vacancy rate may be lower than the recorded vacancy rate, with
the difference being due to fraud. Thus the analytical data might
substantiate the financial data, while income being received is less than
income due. The auditor should therefore test whether sources of
information are independent or might be subject to the same potential
errors.
7.9.25 Appendix B discusses each of these types of analytical procedures in detail.
The discussion includes a description of how the auditor normally
determines the pre-determined threshold amount.
Comparing current
year’s amounts with
prior years.
Comparing current
year’s amounts with
a prediction of the
current’ year’s
amount.
Uses more rigorous
methods to provide
more accurate
predictions.
Building up an
estimate of an
account balance
from known data.
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7.9.26 The following table provides guidance as to the amount of assurance that
each category of analytical procedure can provide. While guidelines should
not replace the use of professional judgment, the following is typical:
Type of Analytical Procedure
Risk Assurance
Overall reviews for reasonableness 100% 0%
Comparative analysis 70% or more Up to 30%
Predictive analysis 50% or more Up to 50%
Statistical analysis 30% or more Up to 70%
Overall verification procedures 10% or more Up to 90%
7.9.27 The Standard Audit Working Paper Kit contains an Analytical Procedures
Assessment Form that can be used to assess the amount of assurance that
the auditor can derive from the different categories of analytical procedures.
7.9.28 Appendix B also discusses the fact that computer-assisted auditing
techniques (CAATs) are a very useful tool for performing analytical
procedures. With the use of a CAAT, the auditor can perform numerous
analyses instantaneously. If performed manually, the equivalent work could
consume extensive audit effort.
7.9.29 CAATs are discussed in more detail in Appendix C.
Substantive Tests of Details
7.9.30 Substantive tests of details include such procedures as physically inspecting
an asset, checking transactions recorded in the books and records to
supporting documentation, and confirming amounts with third parties.
7.9.31 The auditor usually tests a sample of transactions as opposed to verifying
100% of them.
7.9.32 Appendix B contains a detailed description of sampling.
7.9.33 Substantive tests of details can involve more than sampling. There are often
specific transactions and events that the auditor wants to examine. These
could be:
a) Very large transactions and events; or
b) High risk transactions and events.
Substantive Tests of
details include such
procedures as
physically inspecting
an asset, checking
transactions to
supporting
documentation, and
confirming amounts
with third parties.
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7.9.34 These transactions and events are often referred to as “individually
significant transactions and events”. They are often audited 100% because
they are large enough that, should they be in error, the error could be
significant. The auditor therefore does not want to risk failing to find an
error in these transactions or events.
7.9.35 Auditors often audit 100% of the individually significant transactions and
events, and audit a sample of the remaining transactions.
Compliance with Authority Tests
7.9.36 The first step for the auditor is to work with entity management to identify
the rules and regulations that apply to the entity. Of these, the auditor will
determine which authorities are most significant and will design tests to
check compliance. The auditor will also determine what sampling
approach is appropriate. Sampling is discussed at length in Appendix B.
7.9.37 The auditor will then plan to extract the samples as determined, and apply
the compliance tests.
The Audit Risk Model
7.9.38 The audit risk model is a useful way to tie together all of the various
sources of audit assurance.
7.9.39 The basic theory behind the audit risk model is that, for errors adding up to
more than materiality to remain in the accounts at the end of the audit (audit
risk - AR), all of the following must have happened:
a) The errors must have occurred in first place (inherent risk - IR);
b) The internal controls must have failed to prevent or detect the errors
(control risk - CR); and
c) The auditor’s substantive procedures (analytical procedures and
substantive tests of details) must have failed to detect the errors
(detection risk - DR).
7.9.40 Basic probability theory states that, if two events are mutually exclusive
(the occurrence of one is not affected by the occurrence or non-occurrence
of the other), then the probability of both events occurring is the probability
of the first event occurring times the probability of the second event
occurring.
7.9.41 All of the events in paragraph, as defined, are mutually exclusive, and all
must occur before errors adding up to more than materiality remain in the
accounts at the end of the audit. We therefore have the following formula:
AR = IR x CR x DR; where:
AR = Audit risk;
IR = Inherent risk;
CR = Control risk (achieved); and
DR = Detection risk.
Identify the rules
and regulations
that apply to the
entity.
The audit risk model
is a way to tie
together all the
sources of audit
assurance.
Audit Manual – Chapter 7
7-47
7.9.42 The reason for qualifying the control risk as being “achieved” is because
the auditor needs to validate his/her control assurance. What goes in the risk
model is the converse of the achieved assurance.
7.9.43 The audit risk model is often expanded upon to split detection risk (DR)
into two parts. This is done for two reasons:
1. Analytical procedures are often effective and efficient at obtaining
audit assurance. As a result, they should normally be performed on
every audit. The assurance to be achieved from these procedures
needs to be reflected in the risk model;
2. The auditor often performs more than one substantive test of detail to
obtain the required assurance with respect to each specific financial
audit objective and related compliance with authority objective. To
link the risk model to the confidence level to be used for one key
substantive test of details, these other substantive tests of details need
to be considered separately.
7.9.43.1 It is done as follows:
AR =IR x CR x DR
= IR x CR x OSPR x STDR; where:
AR = Audit risk;
IR = Inherent risk;
CR = Control risk (achieved);
OSPR=Other substantive procedures risk, being the risk
that the auditor’s analytical procedures, and all
substantive tests of details expect one key
substantive test of details, will fail to detect
material error; and
STDR =Substantive test of details risk, being the risk that
one key substantive test of details will fail to
detect material error.
7.9.44 The reason for splitting out one key substantive test of details in this
manner is that the formula can be rearranged as follows:
STDR = AR .
IR x CR x OSPR
7.9.45 The resulting STDR is the converse of the confidence level that the auditor
will use for his/her substantive sample. For example, if STDR is determined
to be 15%, the auditor will use an 85% confidence level for his/her
sampling procedures.
Considering the Assurance Achievable from Each Audit Step
7.9.46 Auditors are not required to develop the detailed audit programmes during
the Planning Phase. However, the auditor should give some consideration
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Audit Manual – Chapter 7
to the types of procedures, and the assurance that can be derived from each
procedure, in order to make a reasonable determination of the optimum
combination of sources of audit assurance.
7.9.47 The amount of assurance that can be derived from each procedure depends
on the nature of the test and the evidence that will be collected. The auditor
should have a sound understanding of:
a) The nature of evidence;
b) What constitutes appropriate quality and quantity of evidence; and
c) The most appropriate methods of collecting evidence.
Considering Staffing, Budgeting and Timing of the Audit
7.9.48 The staffing, budgeting and timing of the audit are all matters to be dealt
with in detail at the detailed planning stage. They are discussed in detail in
Chapter 8.
7.9.49 However, the auditor should give these matters some consideration during
the general planning phase. There is no point coming up with an optimum
combination of tests of internal control, analytical procedures and
substantive tests of details unless adequate time or resources are available.
7.9.50
Staffing. Unless an audit is appropriately staffed, the benefits of good audit
planning can be lost. Persons involved in the general planning phase need
to make sure that there are staff members available who have the audit
skills required to perform the work efficiently and effectively.
7.9.51 For example, the auditor may determine that the most efficient audit
approach would be to place high reliance on internal controls and to use
regression analysis. However, unless the audit can be staffed with people
capable of doing a detailed evaluation of an internal control structure and
using a regression analysis software package, this approach is not
practicable.
7.9.52
Budgeting the work. DAGP has finite resources, so it is important to
estimate the time required to perform the audit under each combination of
tests.
7.9.53 Each financial audit will require a minimum amount of resources. DAGP
needs to ensure that the required resources are allocated. Since the
resources required for compliance with authority work can be more flexible
than those required for financial certification, The Director may have some
scope for reallocating resources in response to certification audit demands.
7.9.54
Timing of the work. Most government entities have the same year-end date
(30 June). To keep audit staff busy throughout the year, and complete the
audit of the financial statements on a timely basis after the year-end date, it
is often appropriate to perform some of the work in advance of the year-end
date. This should be taken into account when scheduling audit activities.
Audit Manual – Chapter 7
7-49
7.9.55
Supporting software. Audit management software can be used to assist in
the staffing, budgeting and timing of the audit work.
Re-assessing the general planning decisions for individual audits
7.9.56 Before completing the general planning phase, the auditor should consider
whether decisions made in later steps in the phase indicate that changes are
needed to decisions made earlier in the phase. For example, the assessment
of inherent risk and control risk may result in the auditor re-estimating the
amount required for the expected aggregate error. Similarly, staffing and
timing issues may affect the auditor’s ability to use the optimum mix of
tests of internal control, analytical procedures and substantive tests of
details.
7.9.57 In addition, audits cannot be planned in isolation. Each audit directorate
needs to consider how best to utilise all of its staff members on all of its
audits in the most efficient and effective manner. Planning decisions should
also be re-assessed in later stages of the audit.
7.10 Reliance on Other Auditors
7.10.1 A key factor to consider in the general planning phase is the extent to which
the auditor can rely on the work of internal auditors.
7.10.2 Reliance on internal auditors can affect the work required to update the
understanding of the internal control structure. It will also likely affect the
assessment of control risk.
7.10.3 In addition, the ability to rely on internal auditors will likely affect the
optimum mix of tests of internal control, analytical procedures and
substantive tests of details.
Internal Auditors
7.10.4 Internal auditors have an independent appraisal function within their
organisations. As such, they are part of the entity’s internal control
structure.
7.10.5 In general, the relationship between DAGP and the internal audit
community should be one of cooperation and professional reliance.
Coordination of work can ensure adequate audit coverage, while at the
same time minimising duplicate efforts.
7.10.6 The coordination and cooperation between DAGP and each internal audit
organisation can be enhanced by:
a) DAGP and the internal audit unit coordinating their audit effort,
which in turn requires each:
i) To have knowledge of the planned audit coverage of the
other; and
The relationship
between DAGP and
internal audit
should be one of
cooperation.
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Audit Manual – Chapter 7
ii) To the extent possible, to amend its plans to better
coordinate the effort.
b) Having access to each other’s audit programmes and internal control
questionnaires;
d) DAGP having access to the working papers of the internal audit
organisation;
e) Having an exchange of audit reports and management letters;
f) Having a common understanding of audit techniques, methods, and
terminology; and
g) DAGP relying, to the extent possible, on the audit work of the
internal auditors, and thus reducing the amount of additional testing
required by the DAGP auditors.
7.10.7 Coordination of effort requires that DAGP and the internal audit staff meet
well before the commencement of specific audits to jointly plan their work
for the following year. During these meetings, DAGP could, for example:
a) Discuss areas where it would like to rely on the work of internal
audit;
b) Provide the internal auditors with its basic planning parameters –
materiality, audit risk, sources of audit assurance, etc.;
c) Provide the internal auditors with an audit programme, summary of
unadjusted differences and other forms and checklists for the
internal auditors to complete; and
d) Discuss the timing of the work and any required deadline dates.
7.10.8 One of the roles of internal audit is to provide management with an
assessment of the adequacy and effectiveness of the internal control
structure and the extent to which it can be relied upon. Auditors from
DAGP should consult with the head of the internal audit organisation to
determine how much audit work internal audit has performed on the
internal controls. Wherever possible, the DAGP auditors should rely on the
work of internal audit.
7.10.9 Just like any other control, the unit’s work needs to be tested before it can
be relied upon. DAGP auditors should consider examining the systems and
procedures that the internal audit unit has in place to ensure that its work is
performed to the required standards. These systems and procedures would
include the unit’s quality assurance procedures, hiring policies and training
programme. The DAGP auditors may also wish to re-perform some of the
work performed by internal audit.
7.10.10Sometimes the external auditors use internal auditors to perform some of
the external audit work. In cases such as this, the internal auditors are
effectively acting as members of the external audit team. Their work should
be supervised and their files reviewed just like the work of any other
member of the team.
Consult with
internal audit to
determine how much
audit work internal
audit has performed
on the internals
controls.
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7-51
7.11 Documenting strategic planning decisions
The Need to Document Planning Decisions
7.11.1 The auditor’s documentation, in the form of audit files, is collectively
referred to as the “working papers”.
7.11.2 Paragraph 3.5.5 of DAGP’s auditing standards states, “Auditors should
adequately document the audit evidence in working papers, including the
basis and extent of the planning, work performed and the findings of the
audit.”
7.11.3 Documentation of the planning decisions is discussed in detail in Chapter 8.
At the end of the detailed planning stage, all steps in the planning process
should be complete and adequately documented.
7.11.4 It should be noted that the documentation of the audit planning phase
should not wait until the detailed planning steps are complete. The work
done in each step of the audit planning phase should be fully documented as
soon as the work has been completed.
7.11.5 At the end of the audit planning phase there should be documentation in the
planning file and in the permanent file of all of the decisions made during
the general planning phase. In addition, the relevant sections in the audit
planning memorandum should be completed. The individuals completing
the detailed planning phase can then make use of all of this material.
7.12 Application to Government-wide Audits
Sample Selection
7.12.1 As noted earlier, the auditor uses one overall materiality amount for the
audit, and does not need to allocate it to each grant, component, location,
etc. In addition, this one overall materiality amount is used when
determining minimum sample sizes for the audit of each component, and
each specific financial audit objective and related compliance with
authority objective. (Note: this is not to limit the discretion of DAGP to
perform more rigorous sampling as it sees fit, especially for compliance
with authority audit work).
7.12.2 For government-wide audits, the materiality amount will be established by
a central DAGP team that is responsible for the overall planning,
performance, evaluation, reporting and follow up of the audit. For the audit
of the financial statements of an individual government agency, the
materiality amount will usually be set by the audit director or a more senior
staff person.
Auditors should
document evidence
in working papers,
including the basis
and extent of the
planning, work
performed and
findings.
The auditor uses one
overall materiality a
amount for the
audit, and does not
allocate it to each
grant, component,
locations, etc.
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Audit Manual – Chapter 7
7.12.3 Each ministry, department etc. performs accounting functions at different
locations – the Account General Pakistan Revenues, principal accounting
officers in the ministry or department, DAOs, DDOs, etc.
7.12.4 Using one overall materiality amount ensures that every grant that is greater
than the materiality amount, and every location with assets, liabilities,
revenues or expenditures greater than the materiality amount will be
virtually certain to have at least one transaction selected for audit.
Similarly, each grant and each location with assets, liabilities, revenues or
expenditures greater than one half of the materiality amount will also be
likely to have at least one transaction selected for audit. It is possible that
sampling techniques will not select items from all DDOs, DAOs etc.
(DAGP has full discretion to extend sample selection to include items from
every DDO and DAO if it is considered necessary).
7.12.5 In addition, for the audit of the Federal Government, a province or a
district, the auditor is again using a single materiality amount for each audit
entity, and that amount is based on the assets, liabilities, revenues or
expenditures of that entity as a whole, not each of the sub-entities, such as
ministry or department, within the audit entity. Therefore it is possible that
sampling techniques will not select audit items from some of the smaller
sub-entities. This is logical, since sub-entities that are small relative to
materiality are not significant from a financial audit perspective.
7.12.6 However, with direction from DAGP, auditors have the freedom to extend
the scope of their audit to extend audit coverage to as many sub-entities as
deemed appropriate, and the coverage within each sub-entity, even 100%
sampling, is also discretionary. Auditors often accomplish this by
developing a list of minimum procedures to be applied at specified subentities
that is applied over and above the samples determined by sampling
techniques. Procedures that can help identify additional areas where
coverage would be useful include:
a) Updating knowledge of the business by looking for new legislation,
reviewing minutes etc.,
b) Reviewing the basic control environment;
c) Performing analytical procedures on each line item in the financial
statements (including statement of appropriations); and,
d) Exploring for significant events and transactions after the year-end cut-off
date.
7.12.7 The auditor could also select additional transactions at random and perform
various tests on those items. Bear in mind that the most useful test, given
the small size of some sub-entities relative to materiality, is to look for
unrecorded transactions rather than errors in recorded transactions. In
particular, the auditor would look for unrecorded expenditures that could be
hiding over-expended appropriations.
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7-53
7.12.8 The choice of which grants, locations, ministries or other sub-entities on
which to perform these discretionary procedures is based primarily on the
auditor’s professional judgement and knowledge of the entity. The auditor
should consider the following:
a) The grants, locations, ministries, etc. suspected of significant inherent and
control risk;
b) Sub-entity headquarters where records are kept and where management
likely exerts the most influence over transactions; and
c) All individually significant events, transactions or sub-entities.
7.12.9 In addition to extending the coverage of planned financial audit procedures,
the auditor may also decide to conduct additional audit work to review
compliance with authority, internal controls, performance and so on.
Coordination
7.12.10It is not feasible for each audit directorate to plan its portion of the audit of
the Federal Government, province or district in isolation. The materiality
amount and planned precision value need to be set and the audit work on
each component (e.g. line item in the financial statements) should be
coordinated across ministries, departments, agencies, etc.
7.12.11A single grant may be spread across a number of departments, and one
DAO may manage more than one grant. It is essential that each grant is
subject to an appropriate level of investigation. DAGP has created a central
team responsible for audit planning, performance, evaluation, reporting and
follow up of each government wide audit. For the annual audit of the
financial statements of the Federation, the central team is responsible for:
a) Setting basic planning parameters (materiality, audit risk, planned
precision, components to audit, etc.);
b) Setting inherent risk, control risk, other substantive procedures risk and
substantive test of details risk for each component and audit objective,
compliance objective, error and irregularity;
c) Determining optimum mix of tests of internal control, analytical
procedures, and substantive tests of detail for each component and audit
objective, compliance objective, error and irregularity;
d) Drafting audit programmes, forms and checklists to be used by audit teams;
e) Performing overall error evaluation; and
f) Reporting the results of the audit.
Audit work on each
component should be
coordinated
Audit Manual – Chapter 8
8-1
8.
ACTIVITY AND RESOURCE PLANNING
FOR INDIVIDUAL AUDITS
8.1 Introduction
8.1.1 This phase primarily involves using the decisions made during the audit
planning phase to update the audit programmes that will be used in the
fieldwork phase. It is also concerned with updating budgets, staffing
requirements, the timing of the audit work, and the information to be
obtained from the entity.
8.2 Formulate/update Audit Programmes
8.2.1 The audit programmes provide the auditor with a list of all the procedures
that he/she is to perform.
8.2.2 As discussed in Section 3.5 of DAGP’s auditing standards, the audit
findings, conclusions and recommendations must be based on evidence.
The audit programme must contain all of the procedures necessary for the
auditor to obtain sufficient, relevant, timely, reliable and objective evidence
to support his/her audit findings.
8.2.3 The Standard Audit Working Paper Kit and the Audit Programme Guides
for specialised audit areas provide a good starting point for the audit
programmes to be used on any entity. The kit and guides contain the
following components:
a) Internal control questionnaires (ICQs) and tests of internal control;
b) Analytical procedures; and
c) Substantive tests of details.
8.2.4 The kit and guides also contain various planning documents, checklists,
forms and supervision instruments.
8.2.5 This material cannot be used blindly, even on those audits where the auditor
has extensive material. All entities are different, and each entity can change
over time. Therefore, there is always a need to use professional judgment.
For example:
a) If limited reliance is being placed on the internal control structure, then
some of the procedures in the Internal Control Questionnaires can often be
deleted, or the work required for specific procedures can be reduced.
b) If a lot of reliance is being placed on the internal control structure, then
some of the substantive tests of details may not be necessary, or the extent
of the work required in some of the procedures could be reduced.
The audit
programme must
contain procedures
necessary to obtain
sufficient, relevant,
timely, reliable and
objective evidence to
support audit
findings.
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Audit Manual – Chapter 8
8.2.6 When developing an audit programme, or tailoring one that is already in
existence, it is important to ensure that the programme will provide
sufficient, relevant, timely, reliable and objective evidence for each specific
audit objective, related compliance with authority objective, and error
condition.
8.2.7 As a starting point to assist in this process, the audit programme guides
contained in the Standard Audit Working paper Kit and the Audit
Guidelines contain a column that indicates for which objective the
procedure is designed to provide assurance. Once the auditor has
completed tailoring the programme for the specific entity, the auditor
should then ensure that each specific objective contains an adequate, but not
excessive number of procedures to test it.
8.2.8
Nature. Some procedures, by their nature, will provide more assurance than
other procedures. They may be more relevant, more reliable, more
objective, etc. To assess the amount of assurance that the auditor can derive
from a particular audit procedure, the auditor needs to have a sound
understanding of:
a) The nature of evidence;
b) What constitutes an appropriate quantity and quality of evidence; and
c) The most appropriate methods of collecting evidence.
8.2.9
Extent. The extent of testing relates to how much work the auditor performs
– the size of the sample, the number of observations he/she makes, the
threshold amount selected for following up significant fluctuations from an
analytical procedure, etc. The audit risk model and the guidance provided in
Annexes B and D may be useful for this purpose.
8.2.10
Timing. Timing relates to the period covered by the test. Generally, the
longer the period of time being covered by the test, the more assurance the
auditor can derive from it. For example, a test of internal control that covers
transactions for the entire year is better than a test of internal control that
covers only a few months. This is why, if high reliance is placed on internal
controls, the auditor normally samples transactions from the entire year.
Similarly, a cut-off test that covers the transactions for a month after the
year end would be a better test than one that only covers the transactions for
a few days after the year end.
8.2.11 The requirement to consider the nature, extent and timing of each procedure
applies to entity audit teams who are completing audit programmes
developed by a central team. For the audit of the financial statements of the
Federation, for example, entity teams will be provided with audit
programmes prepared by a central team. However, these audit programmes
cannot be used blindly. It is the responsibility of each entity team to review
the programmes to ensure that:
a) They contain all of the necessary audit procedures and that the required
assurance will be achieved; and
b) They do not include unnecessary audit procedures or involve more work
than is required.
Audit Manual – Chapter 8
8-3
8.2.12 However, audit programmes for each specific financial audit objective and
compliance with authority objective are not developed in isolation, for
several reasons:
a) Many internal controls, such as those that are part of the control
environment, will be common to many components, specific financial audit
objectives, related compliance with authority objectives and error
conditions. The tests of internal control performed on these controls can be
used to provide assurance for all of these components, specific financial
audit objectives, etc.
b) Some components are related to other components. For example, an
understatement of expenditures may also result in an understatement of
liabilities and/or an overstatement of cash. Therefore, the audit of each of
these components will provide the auditor with some assurance as to the
completeness and accuracy of the related components. To avoid doing more
work than necessary, the auditor needs to take the assurance achieved from
auditing the related components into account. Professional judgment is
required.
8.3 Updating staffing requirements and allocating
resources
8.3.1 The audit must be appropriately staffed to achieve its objectives.
8.3.2 Audit planners should ensure that the staff members assigned to the audit
have the audit skills required to perform the work efficiently and
effectively.
8.3.3 Changes to the nature, extent and timing of the audit work may affect the
levels of staff required to perform the work, and the assignment of specific
staff members to the audit. Staffing requirements need to be updated at this
time.
8.3.4 For example, if the auditor wishes to reduce the size of substantive samples
and increase reliance on internal controls and analytical procedures, and
also intends to introduce CAATs, then the staff members assigned to the
audit should have the required training to carry out the tests of internal
control, the analytical procedures, and the CAATs.
8.3.5 For the audit of the financial statements of the Federation and other audits
where a central team makes the initial planning decisions, the central team
will often be making its planning decisions on the assumption that each
entity team will be able to provide the staff members with the required
technical and supervisory skills to perform the audit as planned. It is the
responsibility of each entity team to review the proposed audit plan and to
discuss any potential staffing problems with the central team before
commencing the work.
Ensure that staff
members assigned to
the audit have audit
skills.
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Audit Manual – Chapter 8
Factors to Consider
8.3.6 When assigning specific staff to audits consider the following:
a) The required skill mix for each specific audit. Ensure that each audit team is
composed of staff members with the technical and supervisory skills that
are required to complete the audit.
b) The needs of all the audits in the directorate. Better auditors should be
assigned to the more difficult and risky assignments.
c) The audit deadline. Should the deadline date for an audit be moved forward,
the auditors may have less time after the year end to complete their audit.
This may necessitate adding extra staff to the audit to complete it in a
shorter period of time.
d) Audit continuity. Having at least some of the audit staff members return to
perform work on the entity the next year will help to ensure that the audit
team has the required knowledge of the entity.
e) Rotation. Changing audit staff every few years can add new ideas to the
planning and performance of the audit. It can also help to ensure that the
auditors remain independent of the entity being audited.
f) Learning and advancement. While it is beneficial for some staff to return to
an entity, it’s also advantageous to give them more challenging work each
year. At the same time, they could provide advice and assistance to the
more junior auditors who are performing the work that they performed in
the previous year.
8.3.7 Audit management software will assist in making these staffing decisions.
Allocating resources
8.3.8 The specific audits planned for the period may have to be changed if certain
audit skills or experience within the Audit Directorate (or supplied from
elsewhere within DAGP) are overextended. The Audit Director should
ensure that not only can the proposed set of audits be conducted within
available resources but also that there are specific resources with required
skills available to conduct the audits. For example, if there is only one
person capable of conducting audits of IT systems under development, the
Director should ensure the total audit workload of this type across several
audits does not exceed the time available.
8.3.9 This can be managed by drawing up a matrix assigning audit resources
against audit tasks to enable the manager to balance workload with
available resources.
8.4 Updating budget requirements
8.4.1 Any changes made to the nature, extent and timing of the audit procedures
will most likely affect the budgets for the work. The auditor should update
the budgets at this time.
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8-5
8.4.2 The audit budget should include a projection of:
a) costs of travel, accommodation and subsistence while visiting audit sites;
b) cost of any purchases;
c) level of effort of audit team members.
8.4.3 The biggest aspect of budgeting is the budgeting of time – estimating the
amount of time required to:
a) Plan the audit;
b) Perform the audit of each specific component, and in total;
c) Evaluate the audit results;
d) Report the results of the audit;
e) Follow up the results of previous audits (if being done at this time); and
f) Manage the audit, including the supervision of lower level staff and a
review of their work.
8.4.4 Good budgeting is very important for audits where an opinion is being
expressed. In these cases, the auditor needs to complete all the activities
that have been deemed necessary to form an opinion, and so needs to ensure
adequate resources (people, time, and money) are available. Where no
opinion is being expressed, the auditor has discretion over the scope of
work performed and can adjust the audit plan to best use the resources that
are available.
8.4.5 For the audit of the financial statements of the Federation and other audits
where a central team makes the initial planning decisions, the central team
will also be providing the entity teams with a budget to perform the work. It
is the responsibility of each entity team to review the budget that it has been
given and to discuss any problems with the central team before
commencing the work.
Factors to Consider
8.4.6 The following factors should be considered when setting the budgets:
a) size of the entity;
b) complexity of the entity and its transactions;
c) audit risk;
d) inherent risk;
e) quality of the internal control structure; and
f) experience of the staff performing the audit.
8.4.7 Each of these is discussed below.
8.4.8
Size of the entity. The size of the entity may only have a limited effect on
the required budget. This is because, as the entity being audited gets bigger,
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Audit Manual – Chapter 8
the materiality amount may increase proportionately. The sample size
required to audit the expenditures in a small entity may be just as large as
the sample size required to audit the expenditures in a large entity.
8.4.9
The complexity of the entity and its transactions. This will likely have a
considerable impact on the budget. Some entities are inherently complex,
and the substance of their transactions may be difficult to determine.
Entities such as these could require a much larger budget than entities that
are straightforward.
8.4.10
Audit risk. The lower the audit risk being taken, the more assurance is
required. Reducing audit risk from 5% to 3%, for example, could add 20%
to the total required audit work.
8.4.11
Inherent risk. The higher the assessed inherent risk, the more assurance the
auditor needs in total from his/her tests of internal control, analytical
procedures and substantive tests of details. Also, the auditor may need to
use a higher expected aggregate error when determining planned precision,
further increasing the required amount of work.
8.4.12
The quality of the internal control structure. It is often more efficient to
place a lot of reliance on the internal control structure and reduce the
substantive tests of details. Should this not be possible because the internal
controls are poor (control risk is high), the auditor may need to increase the
budget. Also, the auditor may need to use a higher expected aggregate error
when determining planned precision, further increasing the required amount
of work.
8.4.13
The experience of the staff assigned to the audit. More experienced staff
should be able to complete the work in a fewer number of hours.
Reviewing and Approving the Budget
8.4.14 The budget for each audit should be reviewed by the Director General
responsible for the audit, and approved by the Deputy Auditor General
responsible for the audit.
8.4.15 Each audit directorate should review the budgets set for each individual
audit within the directorate to ensure that they look reasonable in relation to
each other. Senior DAGP officials could carry out the same review across
all directorates.
8.4.16 Team members should record the time that they spend auditing each
component. Explanations for any deviations from the budget should be
obtained, and the auditor should conclude whether or not the factor causing
the increase or decrease in time is expected to recur in the next year. This
information can be used as a starting point for the following year’s budget.
Team members
record the time that
they spend auditing
each component.
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8-7
8.5 Updating timing considerations
8.5.1 All government entities have a 30 June year end. If DAGP were to wait
until after the financial statements of all of these entities were completed
before commencing work, the audit reports would not be timely and DAGP
may not be able to meet required deadline dates.
8.5.2 To improve the timeliness of the audit reports, and to achieve other
benefits, DAGP should commence work on the audits
before the year end
(i.e., at an interim date).
8.5.3 This approach will be essential for the audit of the financial statements of
the Federation and the provinces since the New Accounting Model calls for
the Auditor-General to issue a report on the financial statements on or
before 30 October.
8.5.4 For the audit of the financial statements of the Federation and other
centrally-planned audits, the central team will request each entity team to
report to it by a certain deadline date. It is the responsibility of each entity
team to discuss, with the central team, any potential problems that it may
have meeting the deadline date before commencing the work.
The Use of Interim Audits
8.5.5 An “interim date” is a date in advance of the year-end date. An “interim
audit” is an audit performed at an interim date.
8.5.6 To illustrate, the auditors could decide to perform an audit of the
transactions for the first six months of the year (1 July to 31 December) in
the following February and March. They could then return to the entity in
May to do the next three months (1 January to 31 March). They could then
return again after 30 June to complete their audit.
8.5.7 The work performed at an interim date could include:
a) Auditing a sample of revenue and expenditure transactions up to the interim
date. A sample of the transactions for the rest of the year could then be
audited at a later interim date, or after the year-end.
b) Reviewing and testing the entity’s internal control structure. Enquiries,
observations and walk-through procedures could then be performed at the
year-end date to ensure that the internal controls had not deteriorated.
c) Note: When high reliance is being placed on the internal controls, the
auditor normally needs to also sample the transaction between the interim
date and the year-end date.
d) Discussing accounting policies, the form and content of the financial
statements, contentious authority matters, etc. with entity officials. This
could avoid having to deal with these matters at the end of the audit.
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Audit Manual – Chapter 8
8.6 Factors to consider when determining the optimum
timing
8.6.1 The key benefit of using interim dates is to improve the timeliness of the
audit reports.
8.6.2 Another benefit of using an interim audit is that it can provide the auditor
with an earlier indication that the planning decisions may need changing.
For example, the auditor may have intended to place a lot of reliance on the
internal controls, but may find at an interim date that the controls are not
reliable. The auditor would then be able to amend the audit plan well before
the year-end date.
8.6.3 A further benefit of performing an interim audit is that it may solve staffing
problems. The required staff may not be available to do all of the audit
work after the year-end date. Also, there may be a need to do some of the
work before the year-end to keep all of the staff fully occupied.
8.6.4 The major drawback of doing some work at an interim date is that it may
add to the cost of the audit. If, for example, the bank reconciliations were
verified before the year end, the auditor would normally need to review the
transactions that took place between the date of the in term work and the
year end.
8.7 Updating information required from the entity
8.7.1 It is entity management’s job to ensure that the financial statements, and the
supporting books and records, are complete and accurate. To do so,
management should be preparing its own analyses of the account balances,
reconciling accounts, preparing lists of specific assets and liabilities making
up various account balances, checking the year-end cut-off, doing searches
for unrecorded transactions, etc.
8.7.2 The auditor could make use of the above work to reduce the audit effort. To
do so, the auditor should prepare a list of all of entity management’s
analyses, reconciliations, schedules, lists, etc. that would be useful for the
audit, and submit the list, with a request for copies, to entity management
well in advance of the commencement of the audit.
8.7.3 This process will not only help to improve the efficiency of the audit, but
will also be a good test of the extent to which entity management has
fulfilled its own responsibilities.
8.7.4 The Standard Audit Working Paper Kit includes a form that outlines the
typical forms, schedules, reconciliations, analyses, documents, etc. that are
often requested from entity officials.
It is entity
management’s job to
ensure that the
financial
statements, and the
supporting books
and records, are
complete and
accurate.
Audit Manual – Chapter 8
8-9
8.8 Re-assessing the general and detailed planning
decisions for individual audits
The Need for Re-assessments
8.8.1 Decisions made in the detailed planning phase could result in changes being
needed to decisions made during the general planning phase. For example,
staffing and timing issues may affect the auditor’s ability to use the
optimum mix of tests of internal control, analytical procedures and
substantive tests of details.
8.8.2 In addition, audits cannot be planned in isolation. Each audit directorate
needs to consider how best to utilise its entire staff on all of its audits in the
most efficient and effective manner. This could result in some individual
audits not being done in the most efficient and effective manner.
8.8.3 As we will see in later chapters, the general and detailed planning decisions
should also be re-assessed in later stages of the audit.
8.9 Documenting the detailed planning decisions
The Need for Documentation
8.9.1 Paragraph 3.5.5 of DAGP’s auditing standards requires: “Auditors should
adequately document the audit evidence in working papers, including the
basis and extent of the planning, work performed and the findings of the
audit.”
8.9.2 The general and detailed planning decisions are documented primarily
through:
a) An updated permanent file;
b) An updated planning file;
c) An updated audit planning memorandum; and
d) Updated audit programmes.
8.9.3 Updated permanent file
8.9.4 The permanent file contains information that can be useful to the auditor for
several assignments. A sample index for a permanent file is contained in the
Standard Audit Working Paper Kit.
8.9.5 As is illustrated in the working paper kit, the information that is often found
in the permanent file includes:
a) The role of the entity, its vision and mission statements, and its most recent
corporate plan;
b) Copies of relevant government legislation, regulations, guidelines and other
rules affecting operations;
Document audit
evidence in working
paper including the
planning.
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Audit Manual – Chapter 8
c) Organisation charts;
d) Chart of accounts;
e) Summary of accounting principles used by the organisation;
f) Copies of long-term contracts/leases;
g) Copies of loan agreements, schedules of amortisation for debts and special
assets;
h) Extracts of minutes;
i) Special remuneration conditions for senior officers; and
j) Reports to management and management’s response.
8.9.6 Policies and procedures manuals may be in the permanent file if they are
brief or, alternatively, a copy should be kept on the auditor’s premises.
8.10 Updated planning file
8.10.1 The planning file contains support for all of the planning decisions that
have been made. The usual content of these files is illustrated in the
Standard Audit Working Paper Kit.
8.10.2 As is illustrated in these guidance materials, the information that is often
found in the planning file includes:
a) Support for the work performed and the decisions made at each step of the
general and detailed planning processes. This would include the work
performed to update the planning decisions made in previous years
b) An updated audit planning memorandum. See below.
c) Updated audit programmes. See below.
d) Updated budgets, staffing requirements, timing considerations, information
required from the entity, etc. resulting from the detailed planning process.
Updated audit planning memorandum
8.10.3 This document is usually included in the planning file. It summarises the
key planning decisions that have been made, with emphasis on the changes
that have been made to the previous year’s plan.
8.10.4 The usual content of an audit planning memorandum is illustrated in the
Standard Audit Working Paper Kit.
Updated audit programmes
8.10.5 Audit programmes contain the specific audit procedures that the auditor
needs to complete during the fieldwork phase.
8.10.6 Standard audit programmes are included in the Standard Audit Working
Paper Kit. Audit programmes for the 13 specialised areas are included in
the Audit Guides for those areas.
The planning file
contains support
planning decisions.
Audit Manual – Chapter 8
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8.11 Approval of the general and detailed planning
decisions
8.11.1 All planning decisions should be approved before the fieldwork
commences. This is to ensure that:
a) Appropriate and sufficient evidence is obtained to support the opinion;
b) All of DAGP’s auditing standards are complied with; and
c) Only necessary work is performed.
8.11.2 Since the work performed will form the basis for the conclusions reached
and the form and content of the reports being issued, it is important that the
general and detailed planning decisions be reviewed and approved by senior
DAGP officials. It is suggested that the planning decisions be reviewed by
the responsible Director General and approved by the responsible Deputy
Auditor General.
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