Audit Procedures

AUDIT PROCEDURES: The following are important audit procedures-


1. Obtain an understanding of the entity, it's business/environment/ industry, internal control.(generally used for assessing RMM)

2. Test of Controls, procedures used to obtain evidence needed to assess Control Risk(CR).(generally used for assessing RMM)

Simply put- you understand what controls organization has/ believes it has in place,and then you assess whether those controls are actually working as they are supposed to. For example, the accounts payable manual states that, different people are assigned to -
1. Post vendor bills.
2. Approve expense.
3. Approve payment
4. Prepares check.
5. Signs the check.

But on examination you notice that expenses are missing approvals, or the AP Person , is both posting the expenses as well as approving the wire payments, suggesting weak Internal controls, or that the internal controls are not working as they ought to-Suggesting that there's a higher control risk.

3.Substantive test of transaction, procedures to test for the dollar amount misstatement in Financial statements.(generally used for assessing RMM)

4.Test of details of balances, focus on ending General Ledger Balances.(generally used for DR)

5.Analytical Procedures, as an audit test are used to indicate possible misstatement.(generally used for DR)


Note that Analytical procedures are used-
a. For planning the nature, extent, and timing of other auditing procedures (mandatory);
b. As substantive tests to obtain audit evidence (optional);
c. As an overall review in the final review stage of the audit (mandatory).

AUDITING-Kiting/ lapping

The various methods of substantive tests for cash balances are-

1.Bank Reconciliation Statement: As the name suggests, it reconciles the year-end General Ledger Cash account balance to year-end bank statement balance. The Bank statement balance is adjusted for items appearing/ missing in Cash book, and vice versa.So ultimately Adjusted Book balance should be equal to adjusted Cash balance.

2. Bank cut off statement: :It's the regular bank statement for the first few days after year-end, so that amount of deposits in transit and outstanding checks stated on the bank reconciliation can be verified.

3. Bank confirmation : It's a standard Confirmation Form sent by the auditor to each bank with whom the client has done business during the year. The bank has to fill in the information on client's account. The format of the form is on page 18/ A-4 of Becker 2009 material.

Bank Reconciliation Statement

The motive is to reach at the same adjusted balance in both  BANK and CASH.

Begin with the closing balance in Bank-
ADD:
1. Deposits in Transit.
2. Any error resulting in a lesser balance at bank.
-wrong credit/ lesser debit.
LESS:
1. Outstanding checks.
2. Any error resulting in a higher balance at bank
-wrong debit / lesser credit.

ADJUSTED BANK ACCOUNT

Begin with closing balance in CASH -
ADD:
1. Direct collection by bank
2. Any error in the book.
LESS:
1. Bank charges- service charges/ check printing charges or any other charges.
2 NSF checks/ fees.
3. Errors.
ADJUSTED CASH BALANCE

The common adjusted balance is then posted in the General Ledger.

Audit Risk

(AR)Audit Risk, is the acceptable audit risk, that the auditor may, unknowingly, fail to modify appropriately the opinion on financial statements that are materially misstated. Simply stated, its the risk an auditor is willing to take that he might issue a clean report on not so clean financials.


If the auditor decides to lower audit risk, he wants to be more certain that the financial statements are not materially misstated. The two important equations to understand the level of audit risk and determine the audit work are-( terms explained below)

1.AR=RMM*DR

2.RMM=IR*CR

(RMM) Risk of Material Misstatement, the auditor's assessment of risk of misstatement. This risk exist independent of audit and auditor cannot generally It can be understood as,

(IR)Inherent Risk, is the risk of a material misstatement occurring in an assertion assuming no related internal controls.

(CR)Control Risk, is the risk that a material misstatement in an assertion will not be prevented or detected on a timely basis by the company’s internal control.

(DR) Detection Risk, is the  risk that the auditor will not detect a misstatement that exists in a relevant assertion. i.e. risk that the auditors’ procedures will lead them to conclude that a material misstatement does not exist in an assertion when in fact such misstatement does exist.

Audit Procedures
Audit Techniques

Kiting/ Lapping

CASH, is the most liquid asset and has the highest risk of being misstated.
Kiting and lapping are typical examples of stealing money/ embezzlement.

For the purpose of CPA exam, you can understand Kiting/ lapping as methods of hiding/misstating the Company's actual Cash position.

As per Becker textbook, "Kiting occurs when a check drawn on one bank is deposited in another bank and no record is made of the disbursement in the balance of the first bank."

Lets understand this- there are two bank accounts in a company- BANK 1/ BANK 2.

Check is drawn on BANK 1(balance of BANK 1-- decreases) and the check is deposited in BANK 2( balance in BANK 2 -- increases), but thats not what happens.

In Kiting ,  only deposit (in BANK 2) and no disbursement (in BANK 1) is recorded.
So at year end both BANK 1 and BANK 2 shows the higher balance.

Auditors use BANK TRANSFER SCHEDULE, to detect Kiting.

The transfer Schedule records-

• Transfers/ Date of transfers between company bank accounts for a few days before year end.
• Clearing date in the the bank and company's books.

It ensures that withdrawals and subsequent deposits were made in the same period.  

KITING is indicated when the date stamped by the receiving bank (BANK 2)precedes the date on which the disbursement was recorded.

LAPPING
Tags: Kiting, CPA Exam , CPA Forum

LAPPING

Lapping as per Becker text book, involves withholding current receipts of cash or checks and not recording them. The unrecorded receipt is covered by applying a subsequent receipt to the previously unrecorded account.

In simple language,it's cash theft. A debtor of the company deposits $100, which is not recorded, but is misappropriated by the employee, and that shortage is covered with receipts from another customer.Any balance appearing in the 1dt debtor's account( the amount debtor has paid but is not recorded and is stolen) is usually WRITTEN OFF.

Basic study technique

I first went through the lecture with Becker instructors, read the chapter on my own( including the "Homework reading") and did all the questions( including the supplemental one) and that is most important!! Do all the questions, understand the concept-- why your answer is wrong/ why a particular answer choice is right. And its always best to clarify your doubts when you are doing the questions for the very first time. Internet comes really handy when you have no one to ask for help, I referred a lot to http://www.cpanet.com/cpa_forum/default.asp
and IRS website.

If I came across a good question, or a question which would serve as a good example for some concept in the book, I used to note down the question number next to the relevant text in the book, so when I am revising from the book, I can quickly go over the question.