What is Audit Procedures?
Audit Procedures are steps performed by auditors to get all the information regarding the quality of the financials provided by the company, which enable them to form an opinion on financial statement whether they reflect the true and fair view of organisation financial position. They are identified and applied at the planning stage of the audit after determining audit objective, scope, approach, and risk involved.
Audit Procedure Methods
During the process of the preliminary assessment, an auditor is required to identify and ascertain the amount of risk involved and accordingly develop an audit plan. The audit plans should define these steps which will be applied by the auditor to obtain audit evidence.
They can be divided into two types:
#1 – Substantive Audit Procedures
Substantive procedures are processes, steps, tests performed by auditors which creates conclusive evidence regarding accuracy, completeness, existence, disclosure, rights, or valuation of assets/ liability, books of accounts or on financial statements. For any procedure to be concluded, the auditor should collect enough audit evidence so that another competent auditor when applies the same procedure on the same documents, makes the same conclusion. It can be regarded as complete checking. Auditor usually uses this procedure when he is of opinion audit area includes a high frequency of risk.
#2 – Analytical Audit Procedures
Analytical procedures can be defined as tests/ study/ evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. In simple language, certain checks/tests conducted by auditor based on study/ knowledge/ previous year figures to check and form an opinion on financial statements. Depending on the audit area, the analytical audit procedure may differ. For example, the auditor may compare two sets of financial statement of same entity pertaining to two different financial years or sometimes may compare two different entity’s financial data for obtaining audit evidence.
Types of Audit Procedures
- Inspection – Inspection is the most commonly used method. Under this auditor checks every transaction/ document as against written steps, procedures so as to ensure accuracy.
- Observation – Under this technique of audit, the auditor usually tries to inspect others doing/ performing a particular process. For e.g. An auditor may observe steps followed in processing GRN against goods purchased.
- Confirmation – This type is applied to ensure the correctness of financial statement either from internal sources within auditee organisation or from external sources.
- Recalculation – Under this audit method, the auditor usually crosses checks information presented by the client. This is generally used in case of checking mathematical accuracy.
- Reperformance – Using this procedure, the auditor re-perform entire process is performed by the client so as to find out gaps, audit findings, etc.
Practical Examples of Audit Procedures
- The auditor may evaluate customer outstanding balance like by preparing debtors’ ageing schedules etc. The auditor may compare the same for two different audit periods and find conclusions based on thereon. Like if there is no change in credit policy, no major change in sales, debtors balance should almost be the same, etc.
- Ratio analysis: Auditor may use this method like while checking working capital auditor may compare the current ratio of the different reporting period. This comparison of current assets/current liabilities should be almost the same unless the organisation amended its policies related to any of the working capital items.
- The auditor may check and compare the employee benefits expense accounts for the different accounting period. This amount should be the same or rise in accordance with promotion/ incremental policies. If an auditor finds a different reason for rising/ decline other than due to policies or employee turnover, there are chances of fraudulent payments being processed to fake employees through the payroll system.
- Cross-checking any expenses in line with the quantity and rate and matching with actual figures. For example, suppose 5KGs of potatoes of $25/Kg results in 1 KG of potato chips. The auditor should check actual expenditure should be around $25 for producing 1 KG of potatoes chips.
- Examine a trend line of any expenses. This amount should vary in accordance with production. If not matching, there are chances that management may not be correctly recognizing expenses in a timely manner.
Some advantages are as follows:
- It helps an auditor to obtain conclusive and substantial audit evidence for forming an opinion on financial statements.
- Well defined procedures define the quantum of time and energy which needs to be deployed for finding audit evidence.
- Pre-established procedures help an auditor to follow a defined set of steps which needs to be followed for finding audit evidence.
- They also help and auditor to well plan in advance areas which need to be focussed and deciding the type of audit procedure which needs to be applied.
Despite several audit procedures applied by an auditor, he/she cannot conclude whether financial statements prepared presents a true and correct view. An auditor expresses an opinion which is always subjected to inherent limitations of audit which are described as follows:
- Human Error: Despite checking at thorough level, there are chances of being expressed an inadequate opinion due to human errors and omissions. Since there is always a person present behind any machine.
- Absence of Clear Instructions in Accounting: Auditing standards do prescribe series of steps to be followed while conducting an audit but there are situations which are still undefined. Treatment needs presumptions in these cases.
- Existence of Management Fraud: There may be chances of fraud committed at high-level management or by collusion of the group of employees. Since auditor forms an opinion based on data shared by the auditee, the auditee may not be in a position to detect such fraud.
- Judgements: In preparing financial statement there are situations where management needs to make a judgement which may differ from one to another. With this change in judgements, an auditor may not depict the exact position of that business.
Audit Procedures are a series of steps/processes/ methods applied by an auditor for obtaining sufficient audit evidence for forming an opinion on financial statement whether they reflect the true and fair view of organisation financial position. It is mainly of two types – substantive and analytical procedure. depending on risk assessment, auditor applies audit procedures. These helps an auditor to plan audit and accordingly invest time for obtaining audit evidences. Audit opinion, still, is subjected to inherent limitations of an audit.
This has been a guide to what is audit procedures and its definition. Here we discuss its types and examples of audit procedures along with advantages and limitations. You can learn more about financing from the following articles –