FINANCIAL AUDIT METHODOLOGY

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FINANCIAL AUDIT METHODOLOGY

• PETER CARLILL
• UK NATIONAL AUDIT OFFICE

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ROLE OF NAO

• To provide independent information, assurance and
  advice to Parliament on the use of public
  resources
• To help promote better financial management and
  value for money

Our role
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BODIES AUDITED

• CAG audits 600 financial statements covering
  456 billion
• Revenue of 337 billion
• Assets worth 203 billion
• Long term\liabilities of 37 billion

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FINANCIAL AUDIT

• Audit Opinions
• Reports on Accounts
• Advice and guidance

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PERFORMANCE AUDIT

• How well Government policy is delivered
• In particular
• Economy
• Efficiency
• Effectiveness

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IMPACT

• Savings of over 8 every 1 spent by the NAO
• 1.4 BILLION saved over the last three years
• Over 90 PER CENT of PAC recommendations accepted

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WHY HAVE A METHODOLOGY?

• Ensures Auditing Standards are applied
• Ensures consistency across the NAO (600
  accounts)
• Helps achieve a quantifiable level of assurance
  (95 confidence level)

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UNDERSTANDING THE BUSINESS

• AUDITING STANDARD
• In performing an audit of financial statements,
  the auditor should have or obtain a knowledge of
  the business sufficient to enable the auditor to
  identify and understand the events, transactions
  and practices that, in the auditors judgement,
  may have a significant effect on the financial
  statements.

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UNDERSTANDING THE BUSINESS

• THREE AREAS TO CONSIDER
• Ministrys external environment
• Legislative framework
• Overall control environment within the Ministry

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UNDERSTANDING THE BUSINESS

• AUDITING STANDARD
• The auditor should apply analytical procedures at
  the planning stage to assist in understanding the
  business and in identifying areas of potential
  risk.

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MATERIALITY

• AUDITING STANDARD
• Materiality should be considered by the auditor
  when a) determining the nature, timing and
  extent of audit procedures and b) evaluating the
  effect of misstatements

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MATERIALITY

• An audit needs to be planned and conducted so as
  to provide reasonable assurance that the
  financial statements are free from material
  misstatement.
• A matter is considered material if its omission,
  concealment or misstatement could influence the
  decisions of users of the financial statements
  that were taken on the basis of the financial
  statements.

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MATERIALITY

• Usually a percentage (0.5 - 2) of
• Gross Assets
• Gross Expenditure
• Income
• Or, if applicable
• Profit (5-10)

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MATERIALITY

• BUT
• Some items can be material because of their
  sensitivity or by their context, even though they
  may be small in value.

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USE OF MATERIALITY

• Determines our audit approach to different
  account areas
• Helps us conclude on the extent of errors found

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IDENTIFY MATERIAL RISKS

• Normal risk is present where transactions are
  systematically processed, where the management
  and control environment is good and where the
  nature of the transactions themselves does not
  lead to an increased risk of error. In case of
  normal risk we can reduce the scope of audit
  procedures
• High risk is present in any account area where
  the above characteristics do not apply. In case
  of high risk, we take all the assurance we
  require from substantive and controls testing.

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RISKS

• ENTITY RISK
• ACCOUNT AREA RISK

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RISKS

• Plot on the Risk Mapping Diagram
• 1. Computer crash leading to loss of all
  accounting records
• 2. Failure to estimate useful lives of PCs
  leading to incorrect depreciation charges
• 3. Risk of error in social security payments
  because of highly complex regulations and
  frequent changes of staff (Ministrys only
  activity)

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AREAS OF HIGH RISK

• DETERMINE MINISTRYS RESPONSE TO THE RISK (IN
  TERMS OF ADDITIONAL CONTROLS OR SUPERVISION)
• ASSESS THE RESIDUAL RISK AND AUDIT PROCEDURES
  PROPOSED IN RESPONSE

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The Decision Tree The Decision Tree provides a
framework to determine the audit procedures to be
used for each area of the account. The starting
point is our assessment of risk for the entity as
a whole and for individual account areas. Where
we have identified risks of material misstatement
we should look to test controls that have been
identified as mitigating the risks. Where we have
identified no risks of material misstatement we
should still look to test controls relevant to
the account area to provide the majority of audit
assurance. Beyond controls testing the balance
of assurance will come from substantive
procedures, including analytical procedures
(APs). If the account area/balance being
audited is not material it may be sufficient to
rely on an overall review of outtum only, without
testing controls.
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AUDIT PROCEDURESCONCEPT AND DECISION TREE
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UNDERTAKING THE AUDIT

• ANALYTICAL PROCEDURES
• RELINCE ON OTHERS
• CONTROLS TESTING
• TRANSACTION TESTING

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ANALTYCIAL PROCEDURES

• COMPARATIVE
• PREDICTIVE TEST/MODELLING

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RELIANCE

• INTERNAL AUDIT
• OTHER AUDITORS
• OTHER SPECIALISTS (eg BUILDING VALUATIONS)

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ASSURANCE FROM CONTROLS

• AUDITING STANDARDS
• The auditor, in determining the extent and scope
  of the audit, should study and evaluate the
  reliability of internal controls.
• The auditor should obtain an understanding of the
  accounting and internal control systems
  sufficient to plan the audit and develop an
  effective audit approach.

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CONTROLS

• HIGH LEVEL controls are those which affect gt 1
  transaction. For example
• Reconciliations
• Regular monitoring
• Exception reports

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CONTROLS

• Assurance through
• Re-performance
• Examination
• Enquiry
• Observation

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TRANSACTION TESTING

• Transaction testing is expensive, therefore use
  other methods first to reduce the numbers
  required.
• Can use
• Statistical sampling
• Stratified sampling
• Judgemental sampling
• But beware of sample sizes too low or too high

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EVALUATE RESULTS

• Errors lt materiality
• Errorsgt materiality

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REPORT RESULTS