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AUDIT METHODOLOGIES

The audit strategy document describes the audit methodology to be used in


gathering evidence.
Following are the main methodologies currently used by the auditors:
1.
2.
3.
4.
5.

Risk Based Audit.


Top down approach.
System audit.
Balance sheet approach.
Directional testing

Risk based audit:


Consider for example you are auditing a small manufacturing company. The
company owns the land and building in its statements of financial position which it
depreciates over 50 years and has always been valued at cost. The other major
item is inventory.
Now considering the nature of business, inventory is likely to be far more complex.
The chance of audit engagement partner drawing an inappropriate conclusion about
inventory is higher than the risk in connection with land and building.
Under risk based auditing the auditor will do less work on land and building and will
apply more audit procedures on inventory.

Top down approach:


With a top down approach also known as business risk approach, controls testing is
aimed at high level controls and substantive testing is reduced. Following such
approach the auditor:
1. Pays greater attention to high level controls such as control environment and
corporate governance rather than the detailed procedural controls testing
under traditional approaches
2. Apply analytical procedures more heavily to understand the entitys business
rather than to prove financial statement figures.
3. Reduce its substantive testing.

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Advantages:
1. Added value to the clients as the approach focuses on the business as a
whole.
2. Increase efficiency and reduce cost as substantive testing is reduced.
3. Responds to the importance that regulators and government have placed on
corporate governance in recent years.
4. Lower engagement risk through broader understanding of the clients
business and practices.

Systems audit:
Also known as traditional approach to auditing in which auditor assesses the system
of controls (such as for sales, purchases, payroll, receipts and disbursements) put in
place by the management and ascertain whether they are effective enough for the
auditors to reduce their substantive procedures.

Balance sheet approach:


Under this approach the auditor seek to concentrate efforts on substantiating the
closing position in the year, shown in the statement of financial position, having
determined that the closing position from the previous year has been correctly
transferred to be the opening balance in the current year.
Such an approach can be undertaken with reduced element of substantive testing
under business risk approach.
Such approach is effective for small companies whose financial statement contains
very few material items and there are no sophisticated controls in such a company.
But it can be costly as substantive procedure usually takes time to be performed.

Directional testing:
It is a method of undertaking detailed substantive testing. Substantive testing seeks
to discover errors and omissions and the discovery of these will depend on the
direction of the test.
Broadly speaking, substantive procedures can be said to fall in to two categories:
1. Test to discover errors (resulting in over or understatement)
2. Test to discover omissions (resulting in understatements)
Test to discover errors:
Such test starts with accounting records in which transactions are recorded and
then trace to supporting documents.

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Example if the test is to check sales are priced correctly, the test would begin with a
sales invoice selected from the sales ledger. Prices would then be checked to the
official price list.

Test to discover omissions:


These test start outside the accounting record and then check back to those
records.
Example if the test is designed to discover whether all raw material purchases have
been properly processed, the test would start say with goods received notes, to be
checked to the inventory records or purchase ledger.
Directional testing is particularly useful when there is high level of detailed testing
to be carried out for example when the auditors have assessed the companys
controls and accounting systems as ineffective.

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