Running head: THE PROCESS OF AN AUDIT 1

The Process of an Audit

Sharmori Richardson

International College of the Cayman Islands (ICCI)

BE-406

Instructor: Arlene Harris

Due date: 21 June, 2018

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Auditing

Auditing has played a crucial role in instilling integrity among companies when reporting

financial statements to the general public as well as their investors. If you look back in the late

1990’s, there were a series of financial crimes from big corporations such as Enron and World

Com. It was auditors that investigated the crimes and helped formed a safer environment for

investors to invest in companies. The term auditing speaks for itself as it is the “accumulation

and evaluation of evidence about information to determine and report on the degree of

correspondence between the information and established criteria” (Arens et al., 2014). In other

words, “it evaluates the fairness and accurateness of transactions for an organization”

(Investopedia, 2018). To assess the company’s fairness and accurateness, auditors perform an

audit report to form an opinion on a company’s financial statements. This paper will discuss the

procedures taken to complete a full audit report.

Phase One: Plan and Design an Audit Approach

Firstly, the first phase of the auditing process is planning and designing an audit

procedure. To plan and design the audit, the auditor or the audit firm must understand the

industry of the business and its environment; understand the internal control of the business and

Assess Risk of material misstatements.

Objective One: Understanding the Entity and its Environment.

As it relates to the first objective, to assess the risk of misstatements, in the financial

statements and to interpret information obtained through the audit, the auditor must have an

excellent understanding of the client’s business, strategies and processes. (Arens et al., 2014)

The auditor must also understand the accounting treatments for their client’s industry. For
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example, when auditing an insurance company, the auditor must understand how loss reserves

are calculated.

Objective Two: Understanding Internal Control.

Internal controls are described as “methods put in place by a company to ensure the

integrity of financial accounting information, meet operational and profitability targets, and

transmit management policies throughout the organization” (Investopedia, 2015). It is crucial to

the operations of a company and the process of an audit report. It is best utilized when it is

applied through multiple divisions throughout the organization. If internal controls are

considered effective, planned assessed control risk can be reduced, and the amount of audit

evidence to be accumulated can be significantly less than when internal controls are not effective

(Arens et al., 2014).

Objective Three: Assess Risk of Material Misstatement.

After performing first two objectives of the first phase of the auditing process, the auditor will

create the official audit plan, the procedures as well as the duration for the audit to be completed.

At the end of phase one, the auditor should have a well-defined auditing strategy and plan and a

specific audit program for the entire audit.

Problem and Solution.

Problems can have derived in the first phase of the auditing process. For example, one of

your clients’ (insurance firm) Financial controller has been dismissed, and his tasks have been

allocated between the finance department team, which has increased the workload for all

employees. In this case, as an auditor, the student would be very attentive with this situation. As

an employee, taking on another individual’s tasks can seem stressful and overwhelming. Some

employees also don’t have the required skills in completing the tasks. In this case, the student
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would remain alert throughout the audit for accounting errors as well as requesting help from the

finance director to provide the audit team with assistance for auditing issues as there is no

financial controller available.

Phase Two: Perform Test of Controls and Substantive Test of Transactions

Secondly, the second phase of the auditing process is performing tests of controls and

substantive test of transactions. Auditors perform tests of controls and substantive tests of

transactions to obtain evidence in support of the specific controls that contribute to the auditor’s

assessed control risk and to gather evidence in favor of the monetary correctness of transactions.

Test of Controls.

A test of controls is an “audit procedure to test the effectiveness of control used by a

client entity to prevent or detect material misstatements” (Arens et al., 2014). They are

performed either to test the system, because the auditor wants to place reliance on controls or

when substantive procedures on its own cannot produce sufficient appropriate audit evidence.

For this test, the auditor will on test key controls, which are “the controls which contribute to the

reliance the auditor can place on figures in the financial statements” (Messier et al.,2012).

However, if the test reveals that controls are weak, the auditors will enhance their use of

substantive testing, which will increase the time and the cost of the audit (Bragg, 2018).

Substantive Tests of Transactions.

Substantive tests of transactions are “audit procedures testing for monetary misstatements

to determine whether the six transaction-related audit objectives have been satisfied for each

class of transactions” (Arens et al., 2014). Auditors perform substantive tests to obtain sufficient

and appropriate audit evidence to express an audit opinion. The assertions for transactions,

balances or disclosures also with the risks identified during the planning phase, assists the
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auditor in improving substantive procedures (Messier et al.,2012). Auditors perform tests of

controls and substantive tests of transactions at the same time for efficiency.

Problem & Solution.

As phase two plays a crucial role in the auditing process, some problems can derive from

performing the tests. For example, the purchase ledger supervisor left in 4 months ago and no

reconciliations and purchase ledger control accounts have been completed. This has increased

errors within trade payables, and payables might be overstated at the end of the year. In this

scenario, the student would increase the testing on trade payables at the end of the year, with a

particular focus on completeness of payables. A detailed review of the year-end purchase ledger

control account reconciliation should be performed with a focus on any unusual reconciliation

items.

Phase Three: Perform Analytical Procedures and Test of Details of Balances

The purpose of the third phase is to obtain sufficient additional evidence to determine

whether the ending balances and footnotes in financial statements are fairly stated. The nature

and extent of the work will depend heavily on the findings of the first two phases as well as the

categories of the third phase which are substantive analytical procedures and tests of details of

balances.

Analytical Procedures.

Analytical procedures consist of “evaluations of financial statements through analysis of

plausible relationships among both financial and non-financial data” (Arens et al., 2014). The

test plays an important part in a risk-based audit approach. The primary objective of this test is to

obtain assurance, in combination with another audit testing, concerning financial statement

assertions for one or more audit areas (ACCA Global, 2018). Also, with the primary objective of
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analytical procedures, the four steps that are used in the process of analytical methods. These

steps include developing an independent expectation; defining a significant difference;

computing the difference; and investigating substantial differences and drawing conclusions

(ACCA Global, 2018).

Test of details of balances.

Test of details of balances is “an audit procedure that tests for monetary misstatements to

determine whether the eight balance-related objectives have been satisfied for each significant

account balance” (Arens et al., 2014). Test of details of ending balances are essential to the

conduct of the audit because much of the evidence is obtained from third-party sources and

therefore is considered to be of high quality (Arens et al., 2014).

Problem and Solution.

Problems can derive from phase three of the auditing process. For example, Preliminary

analytical review of the profit and loss statement has a suspect that the client is paying fictitious

invoices. This results in a significant increase in expenses. For this scenario, the student would

update the analytical review with the full year results and conduct interviews with management

to gain knowledge about these fictitious invoices. From here, the student will do further test to

obtain additional evidence as to where these fictitious invoices are coming from

Phase Four: Completing the Audit and Issuing an Audit Report

Lastly, the final step in the audit process is to evaluate the results of the audit evidence

and choose the appropriate audit opinion to issue. After completing the first three phases,

auditors must accumulate additional evidence related to presentation and disclosure-related

objectives, summarize the results, publish the audit report and perform other forms of

communication with parties that the audit affects.

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Performing Additional Tests for Presentation and Disclosure.

Additional testing provides evidence supporting completeness and accuracy presentation

and disclosure-related objective, and it also obtains sufficient appropriate evidence that

information disclosed in the footnotes reflects actual transactions and balances that have

occurred and that represent obligations of the client to support the occurrence and rights and

obligation objectives (Arens et al., 2014). Furthermore, auditors perform audit procedures related

to contingent liabilities and subsequent events. A contingent liability is a potential liability that

may occur depending on the outcome of an uncertain future event (Investopedia, 2018). A

subsequent event is an event that occurs after a reporting period, but before the financial

statements for that period have been issued or are available to be issued (Bragg, 2017). Both of

these terminologies will show up in the disclosure of footnotes as they will affect the financial

statements.

Accumulate Final Evidence and Issue Audit Report.

In addition to performing additional tests, an auditor must gather the four types of

evidence for financial statements as a whole during the completion of the phase. This evidence

includes performing final analytical procedures, evaluating the going-concern assumption,

obtaining a client representation letter and reading information in the annual report to make sure

that it is consistent with the financial statements. Once this evidence is combined, the auditor can

now issue an audit report. The types of auditing reports are unqualified opinion, qualified

opinion, an adverse opinion and a disclaimer of opinion audit report.

Communicate with Audit Committee and Management.

After the posting of the audit report, the auditor is required to communicate significant

deficiencies in internal control to the audit committee or senior management. Auditors are also
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expected to communicate certain other matters to those charged with governance, such as the

audit committee or a similarly designated body, upon completion of the audit, if not sooner.

Problem and Solution.

Just like the first three phases, phase four can also create a problem. For example,

completed the audit report and as a result of conducting the audit, the company did not maintain

GAAP accounting principles. Instead of writing a qualified report, you wrote an unqualified

report. In this case, the student would follow AICPA auditing standards on how to write a

qualified report and learn the structure of report so a mistake like that can never happen again.

Conclusion

After eleven weeks of learning about the auditing industry, the student concludes that the

four phases are crucial to completing an audit. Not only do the four phases need to be carried out,

but auditors need to ensure they carefully look at the financial statements. Sometimes, they are

not able to identify the little errors. Those errors can lead to a more significant issue. Once these

steps are completed, the audit will be successful. The student will also like to thank his

instructor, Dr. Arlene Harris for simplifying and helping him in gaining a better understanding as

his goal is to work in the auditing industry in the future.

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References

ACCA Global . (2018, February 2). Analytical Procedures . Retrieved from ACCA:

http://www.accaglobal.com/crsh/en/student/exam-support-resources/professional-exams-

study-resources/p7/technical-articles/analytical-procedures.html

Arens, A. A., Elder, R. J., & Beasley, M. S. (2014). Auditing & Assurance Services: An

Integrated Approach (15th ed.). Boston: Pearson Education.

Bragg, S. (2017, November 26). Subsequent Events Definition . Retrieved from Accounting

Tools : https://www.accountingtools.com/articles/subsequent-events-definition-and-

usage.html

Bragg, S. (2018, January 20). Test of Controls . Retrieved from Accounting Tools :

https://www.accountingtools.com/articles/what-are-tests-of-controls.html

Investopedia . (2018, June 20). Audirt. Retrieved from Investopedia:

https://www.investopedia.com/terms/a/audit.asp

Investopedia. (2018, June 13). Contingent Liability. Retrieved from Investopedia:

https://www.investopedia.com/terms/c/contingentliability.asp

Messier, W. F., Glover, S. M., & Prawitt, D. F. (2012). Auditing and Assurance Services: A

Systematic Approach (8th Edition ed.). New York City : McGraw-Hill.