As accounting majors; we prefer numbers. It is assumed that accountants love numbers, and personally I prefer them more than words. However when it comes to Auditing; coming up with reports and letters that state the reasonableness of the financial statements credibility is what makes a CPA differ from any accountant.
Out of all the accounting
classes I took in the undergraduate level, Auditing, by far was the hardest
class for me to grasp. Since most of Auditing has to do with real world
experience, it’s tough to grasp what the concepts, purpose and the procedures
that Auditor's perform to assess the credibility of financial statements are,
without actually having any auditing experience myself. One thing I always was
confused about in Auditing was Analytical Procedures and the process of when an
Auditor would exactly implement Auditing procedures. Here is a chart that I
designed to help myself gain a better perspective and understanding of the
procedures during an Audit.
The Audit Risk Model is the most important models used by Auditors; it is used to assess how much work should be performed during the Audit. When an auditor evaluates the risk in an Audit, the auditor undertakes risk assessment procedures. The Audit Risk model takes into consideration three factors.
- Inherent Risk- Basically risk that is in the "genes" of the company, which is unavoidable, it is very important for the Auditor to consider this in evaluating how much Auditing procedures to implement.
- Control Risk- Is the inability that the clients system of internal control can catch any material misstatements in the financial statements. The Auditor cannot change, and must completely consider in implementing Auditing procedures.
- Detection Risk- Is the risk the Auditor will not detect any material misstatements in the financial statements.
- Basically, there is an inverse relationship between Detection risk and Inherent Risk plus Control Risk (Combined). If the Auditor assesses a high Control Risk and Inherent Risk; therefore the Auditor must then decrease the Detection risk and be more vigilant during the Audit. The same is true for the opposite, if the Auditor assesses a low Control Risk and Inherent risk, the Auditor can then increase Detection risk and perform less work to verify the credibility of the financial statements.
After an Auditor analyzes the Audit Risk model, testing the controls is not always mandatory. If the auditor wants to rely on the controls of the entity (assessment of inherent risk and control risk is low), the auditor should evaluate and test the controls. However, if the auditor deems that the controls are weak and ineffective (assessment of inherent risk and control risk are high), there is no need of performing test of controls. To test controls, the auditor implements attribute sampling, which is basically testing how controls are implemented and if there are any procedures taking place to prevent any unfortunate fraudulent behavior.
Substantive procedures refer to testing the validity of dollar account balances. Here is where variable sampling is used by the auditor, in that they help the auditor obtain the validity of account balances. Variable sampling helps by estimating how much of a dollar amount the account may be off or considered inaccurate. (Both Variable & Attribute Sampling should be discussed in greater detail in the Sampling section). The testing can be broken down to two different procedures.
1- One is Analytical procedures, which is performed at the beginning and overall end stage of the audit. Analytical procedures normally are analyzing financial trends, such as ratios, budgets, variances and other financial data.
2- Second is substantive testing, which breaks down into two procedures. These set of procedures are generally used to asses all the assertions (completeness, existence, cut-off, valuation, rights, and understandability) of the financial statements.
- Test of Details, Transactions and Disclosures is a test performed during the audit to where the Auditor tests to make sure the account balances are correctly stated on the financial statements.
- Substantive Analytical Procedures are not always required, they are used and implemented when analytical procedures help the auditor verify account balances efficiently and effectively compared to Test of details.