Question

Describe sampling of internal controls, account balances, and monetary units for an Operation Audit, a Compliance Audit, and a Financial Statement Audit.

Answer 1

1. sampling of internal controls: since co.s large amount of records, it's not possible for the auditor to audit all the data and still get the audit done in tine and in accurate manner. so sampling allows you to choose a significant group of records that will be the representative of the group of the records and that will give the true picture of the company.

sampling of internal controls will be done in following manner:

a. Auditor will pick sample based on the objective of tests of controls to provide the evidence about whether controls are operating effectively. Audit objectives vary between accounts and the purpose of your procedure.

b. Before analyzing a sample, an auditor has expectations about the number of “exceptions” (such as errors and omissions) that will appear in the sample. If the actual exceptions exceed the auditor’s expectation, he or she may need to perform additional procedures. For instance, your auditor might expand the sample and conduct more testing to assess the degree of non compliance in any particular situation.

c. Sampling helps keep audit costs down by streamlining the internal control testing process. When applied correctly, the results of sampling are theoretically as accurate as if the audit team had analyzed every transaction.

-cons of sampling of internal controls: There’s a risk that your audit team could rely too heavily on non statistical sampling. Relying more on judgment than statistical methods could result in errors.

2. sampling of Account Balances: This means the auditor uses sampling to see if the dollar amount on the financial statements for each account is accurate. You also need to make sure that whatever the account balance represents actually exists.

For example, if an organisation's machinery account balance is $100,000 and represents the value of five different machineries, auditor need to make sure that the company actually owns five machineries and that their collective value is indeed $100,000. Sometimes companies forget to remove assets from the balance sheet after the assets have been sold or junked.

Here is an example of sampling of account balances for a general repairs and maintenance expense account. For this example, the monetary unit sampling value will be the total dollar amount of general repairs and maintenance, and the sampling unit is each dollar shown in the expense.

a. test objectives- Auditor will test the reasonableness of the repair and maintenance expense account balance to gain a reasonable assurance that auditor will be able to find material misstatements and be able to correct the financial statements.

b. Defining population characteristics- test accuracy and classification assertions for repairs and maintenance. Confirm proper classification if transactions are recorded in the correct accounts to make sure this account is materially correct.

c. Determine the sample size: based on the risk of incorrect acceptance, confidence level, tolerable error, and expected error.

After that auditor will perform it's substantive audit procedures on the selected sample and draw a conclusion thereon.

3. Sampling of monetary units for an Operation Audit: Operational audits are a forward looking process, and are part of many organizations for improvement in their business processes. The objectives of operational audits are - to diagnose which areas of the entity need attention and to safeguard assets by avoiding the potential future risks. The Institute of Internal Auditors’ (IIA) definition of an operational audit: “A systematic process of evaluating an organization's effectiveness, efficiency and economy (3 E's) of operations under management's control and reporting to appropriate persons the results of the evaluation along with recommendations for improvement.”
A general audit is usually associated with financial matters, operational audits are more comprehensive and go beyond financial data. The primary information sources are policies and achievements related to the objectives of the organization.

Sampling of Monetary unit / Monetary Unit Sampling(MUS): MUS for an operational audit is a statistical sampling method that is used to determine if the account balances or monetary amounts in a population contain any material misstatements. Each individual dollar in the population can be considered a sampling unit, amounts in the population with a higher value have a proportionally higher chance of being selected. Once the testing of a sample has been completed, a conclusion is reached in dollar amounts. MUS methods are relatively simple to use, and so can be an efficient tool for audit testing. MUS advantages can be described as follows:

• easy to apply, use and understand than the classic sampling methods.

• There is no need to consider the characteristics of the population when determining sample sizes, such as the standard deviation of dollar amounts within the population

• If no misstatement is expected, the sample size is quite efficient.

Examples of sampling of monetary units for operational audit:  for accounts receivable confirmations, loan receivable confirmations, inventory valuation tests etc.

MUS also have some disadvantages:

• It will probably not select small recorded amounts.

• Large understatements found in a sample can lead to invalid or vague projections.

• Negative balances need to be dealt with and justified separately.

• The auditor is more likely to reject an acceptable recorded amount for a population.

4. Compliance Audit: A compliance audit is an audit engagement in which the goal is to determine whether an organization is adhering to the terms of a contract or certain rules and regulations. For example, a compliance audit will be done for the purpose of :

• Ensuring that the terms of a bond Contract are being followed.

• Ensuring that the calculation and payment of a royalty are correct.

• Verifying that workers’ compensation pay is being properly reported as per the laws and regulation.

5. Financial Statement Audit: A financial statement audit is an engagement work performed by an independent statutory auditor to provide reasonable assurance that an entity’s financial statements are reported in accordance with accounting principles generally accepted in the U.S. Specifically, certified public accountants, or CPAs, are obtained to provide audited financial statements to businesses, non profit organizations and government agencies. Each audit is customized to meet the needs of the organization but overall approach or we can say crux of purpose of each audit is same.

It can be further elaborated in following phases:

a. Audit Engagement Acceptance:The American Institute of CPAs recommends that an auditor evaluate the risks associated with each engagement. Therefore, a CPA inquires about any special circumstances, the integrity of management and pending lawsuits before performing an audit. Once the auditor decides to accept the engagement, an engagement letter is prepared that details the timing, responsibility and cost and schedule of the audit.

b. Audit Planning: As per the Auditing standards; an auditor prepares adequate planning for an audit engagement. The amount of audit planning needed is in direct relation to the size and complexity of the organization. Audit planning involves- obtaining an understanding of the organization’s business and industry, performing trend and ratio analysis, analyzing entity’s process of internal control and assessing the risk of a misstatement in the entity’s financial statements. The auditor utilizes the results of the planning process to determine the nature, timing and extent (NTE) of audit.

c. In-Depth Analysis: During the analysis process, the auditor ensures that financial statement account balances are supported by underlying documentation and analysis. A CPA evaluatesthe reviews management’s responses to inquires.

d. Audit Reporting: Auditor will issue an opinion on audited financial statements as to whether the financial statements are presented in accordance with accounting principles generally accepted in the U.S.

e. Closure: Auditor is required to retain proper documentation regarding the audit and obtain signatures from management regarding management’s responsibility for the information reported in the financial statements. The information is retained by the CPA for future account analysis.