Types of Audits

Audits can be classified into two broadways.
according to terms of engagement i.e. nature of work done.
according to the approach to the work to be done/ timing.

According to nature of work done, audits may be either statutory of private.

Statutory audits

These are carried out as per the requirements of various statutes e.g. Companies act Cap 486 requires that all public limited companies to have their financial statements subjected to an independent audit. The objective of the audit is to enable the auditor express an opinion whether the financial statements have a true and fair view of the company’s state of affairs. The rights and duties of the auditor are laid down in the relevant statute. The powers of appointment of the auditors are vested on the shoulders.

Private Audits

These are not governed by statutes. They are performed by independent auditors because the owners, members or interested parties require them carried out. private audits are carried out for organizations such as non governmental organizations, partnerships and clubs and among others. appointment of auditors is carried out as a private contract between the auditor and the relevant shareholder. The scope and objective of the work as well as rights and duties of the auditor are determined by the agreed terms between the auditor and the client. The auditor is not liable to third parties.

According to approach of the work to be done, audits can be continuous, interim or final.

Continuous Audits

This is an approach whereby an audit is carried out throughout the financial period usually at predetermined intervals. This approach is ideal for large organizations with tight reporting deadlines e.g. multinational banks. The approach ensures accounts are kept up to date, errors and frauds are discovered in early stages and better audit reports are developed since more time is taken.

however, this approach is expensive considering amount of time taken, has frequent interruptions of client work and auditors’ independence may be affected by their continuous presence at clients premises.

Interim Audits

This is an audit carried out halfway through the financial period. It usually precedes the final audit and is a preparation for the final audit. It is ideal for dynamic businesses, cheaper compared to continuous audits and enhances keeping of up to date records.

Final Audits

These are usually done at the end of the year as either a continuation of the interim audit for large and medium size companies or as a single audit for small companies at end of financial period.

Other types of audits

Procedural audits.

These require examination of procedures or records for reliability and accuracy. They usually relate to company’s internal control systems, laid down guidelines and procedures and records of the company.

Management audits.

These involve investigation of the company’s entire management to ascertain whether the directors are running the company in the most optimal way for the benefit of the shareholders. It improves quality and efficiency of management in addition to checking the budgetary system.

Balance sheet audits.

This tests the strength of internal control system by working backwards to get the initial transactions using assertion methodology.

What is Internal Audit?

management upon realizing the advantages of an audit have established within the company, ‘an independent activity to examine and evaluate the organizations risk management process and systems of control and to make recommendations for the achievement of the company’s objective’. This activity is called internal auditing. The duties of internal audit personnel are:

Reviewing the economic efficiency and effectiveness of the company’s operations.
reviewing the company’s compliance with external laws and regulations and internal policies and procedures.
reviewing and advising the management on development of key organizational systems and implementation of major changes.

The focus of internal auditing is adding value to an organization through improvement in risk control.

in 1999, the institute of internal auditors (IIA) defined internal auditing as ‘an independent objective assurance and consulting activity designed to add value and improve an organization’s operations, help it achieve its objective and improve the effectiveness of risk management, control and governance process.

Differences Between Internal auditing and External Auditing

Aspect	internal Auditing	External Auditing
objectives	The main objective is to advice management on whether organization has sound internal control systems to protect it against loss.	The objective is to provide an opinion as to whether or not the financial statements show a true and fair view of the company’s state affairs.
legal basis	internal auditing is not a legal requirement but corporate governance advises and recommends that a company should have an internal audit department.	it is a legal requirement for limited liability companies and public bodies to have their accounts audited.
Scope	it covers all areas of organization i.e. operational as well as financial.	It has a purely financial focus.
approach	it is increasingly risk based. The approach is to assess risks, evaluate systems of control and test operation of the systems and finally make recommendations for improvement.	its increasingly risk based as it only tests underlying transactions that form having of financial statements.
responsibility	The responsibility is to advise and make recommendations on internal controls and corporate governance.	The responsibility is to form an opinion on whether financial statements show a true and fair view.

Scope & Objectives of Internal Audit Function

This depends on the size and structure of the entity and the responsibility assigned to it by management. ordinarily these would include:

review of accounting internal control systems. The management is responsible for establishing internal control system. The system requires proper attention and continuous review, a function usually assigned to internal audit. internal audit function designs a plan on areas and control procedures that will be reviewed during the financial year.
Carrying out examination of financial and operational information. This may include detailed testing of transactions and operation procedures.
Review of the economic efficiency and effectiveness of operations including non financial controls of the entity.
review of company’s compliance with external laws and regulation. The internal audit functions checks whether procedure are in place to ensure that all relevant laws and regulations are adhered to.
review of entity’s compliance with management policies and other internal requirements.
Carrying out independent investigations into company affairs as required by management

e.g. investigation areas of suspected fraud or misuse of company’s resources.

Similarities Between Internal Audit and External Audit

both auditors are concerned about the strength and proper functioning of the internal control system. The internal auditor is concerned it is his or her responsibility while the external auditor is concerned as he or she relies on the strength of internal control system to carry out systems based audits.
both auditors have as part of their duties to ensure that the company adheres to all relevant laws and regulations.
both auditors interested in ensuring that the company keeps proper books of records. The internal auditor uses the company accounts to appraise the functioning of the internal control system while external auditor uses them to collect audit evidence to corroborate his audit opinion.
both auditors are concerned about prevention and detection of errors and frauds. The internal auditor ensures errors or frauds are prevented and detected by having strong internal control system while the external auditor has the incidental duty of detecting and preventing material errors and frauds which would otherwise distort the true and fair view of the financial statements.
both auditors have interest in safeguarding company assets. The internal auditor through strong internal control system ensures safety of company’s assets while external auditor must ensure that company assets are safeguarded against theft and misuse so that the true of fair view of financial statements is maintained.

External auditor’s reliance on work of internal auditor

before deciding on whether to rely on work of internal audit function with the intention of reducing audit procedures, the external auditor should evaluate the internal audit function to determine the scope of the function its independence and the extent to which its work can be relied on. in evaluating internal audit function, the external auditor considers the following factors:

organization status. Since internal audit function is part of the entity, it cannot be totally independent. To aid in its independence, the internal audit function should report to the highest level of management. The internal auditor should also be free from duties such as accounting functions which may bring about conflict of interest. The internal auditor should not have any restrictions upon him or her from management which could impair effectiveness of doing his or her work.
Scope of the function. The external auditor should ascertain the nature and depth of coverage of internal audit assignments. also to be considered are the management actions on the recommendations of internal auditor. in case the management does not follow up on the recommendations, the external auditor must reduce his reliance on work of internal audit function as this means it is weak.
Technical competence. The external auditor should assess the competence experience, qualifications, technical training and proficiency of the staff members in the internal audit function.
Due professional care. The external auditor should ascertain whether due professional care has been observed in doing the work of the internal audit function e.g. whether there were work plans, supervision and documentation of audit evidence in executing internal audit functions.
availability of resources. The external auditor should consider whether the internal audit function has adequate resources to enable it carry out its functions as expected e.g. adequate staff and time.

Advantages of Internal Audit function

it reinforces application of internal controls thus enables the company to operate in an orderly and efficient way.
it prevents and detects errors and frauds through periodic comparison of budgets, routine and surprise checks.
assists management in implementation of company policies through reporting on adherence or non adherence to laid down policies of the company.
assists external auditor in highlighting areas of weaknesses in internal control system. This reduces audit time for the external auditor and thus there is a saving on audit fees.
assists the company in achieving its objective by ensuring that all laid down rules, procedures and policies are followed e.g. adherence to budgets and forecasts assists in decision making.
The internal audit function guards company’s resources against theft and misuse through proper functioning of the internal control system and periodic verification of assets.

Limitations of an Internal Audit

The cost of installing and maintaining an internal audit function is high and in particular for large companies as they may require highly qualified staff while for small companies the department may not be justifiable.
if management ignores the recommendations of internal audit function, members of internal audit function may be frustrated as errors and frauds may continue being undetected.
management may deny the internal audit function its due independence by assigning it accounting duties or even management responsibilities.
if company operations are few or has complex technical aspects may limit the proper functioning of the internal audit function.
The internal audit department may fail e.g. if it points out problems without giving solutions or ignoring some departments within the company.
The internal audit may lack the necessary support from top level management if top management views the function as not important.

Factors necessitating growth in Internal Audit

increase in business size. as business grow, it becomes more and more necessary to have a function that checks all the increasing levels of internal control and operation.
Dynamic technology– the frequent changes in technology has made some companies to have their controls updated on a continuous basis. This calls for constant feed back on controls requiring updating through use of expert advice for internal audit function.
legislation and regulatory requirements. as the concept of corporate governance becomes necessary in business management, the need of internal audit has increased. Companies are now required by regulations to have audit committees to oversee operation of controls within the company and to which the internal audit function reports.
Competition. High competition in business calls for efficient operations by companies so as to survive. This can be achieved through strong controls and cost effectiveness which is enhanced by internal audit.

COMPUTERIZED INFORMATION SYSTEMS Notes

THE AUDITOR AND THE COMPANIES ACT-Questions and Answers