Introduction
If you’ve been saddled with the responsibility of managing the external audit process from start to finish (as the key contact person), then, this book is for you. To achieve a smooth audit, you must be proactive. Here is a good way to approach it:
“The auditor’s request is driven by his or her procedures. Understanding how an audit works (i.e., the auditor’s procedures), can make you more proactive.”
So, we will first obtain a basic understanding of how an audit works before we examine how to prepare for the audit. Key points to be covered:
1. Overview of the external audit process | 3. Proactive preparation of documents |
2. Preparatory steps | 4. Further tips to make the process easier |
We have uploaded some resources to a google drive which you may find useful. See link to the Google Drive: https://tinyurl.com/bdhrcmt4
Overview of an audit
In recent times, external auditors apply the requirements of the International Standards on Auditing (ISAs). An audit carried out in accordance with the ISAs can be broken down into three (3) phases as seen in the image below. The approach adopted is referred to as the “Risk Based Approach” in which the focus is always on risk of material misstatements (RoMMs) – what can go wrong in the FS.
This book only provides a summary of an external audit exercise. For further details on the overview of an audit, you can download our free e-book from the Google Drive provided above.
1.1. Planning
At planning, the general objective of the auditor’s work is to achieve the following:
1) Understand the entity’s business, industry, and environment
2) From understanding, the auditor will identify Risk of Material Misstatement (RoMMs)
3) Design audit procedures to address the RoMMs.
The auditor deploys some procedures which are itemized below to achieve these 3 objectives. The auditor may choose to work from their office or your office. Also, depending on deadlines, a significant part of the planning procedures can be performed before the end of the year. For example, if your year ends on 31 December 2022, they can perform their planning procedures in November and/or December 2022 to manage the pressure and time constraints that are typical after the year ends.
Key planning activities
Key planning activities | |
1 | Engagement risk assessment |
2 | Team selection |
3 | Audit Request List (See google drive for an example – Information Request List) |
4 | Understanding the entity, its industry and environment |
5 | Engagement team planning meeting (led by the Partner) |
6 | Planning meeting with the client |
7 | Determine materiality |
8 | Understanding (entity level) internal control (components of internal control under the COSO Framework). |
9 | Control testing |
10 | Analytical procedure (AP) |
11 | Going concern at planning |
12 | Assess inherent risks and identify material FS items |
13 | Design procedures for risks identified |
1.1. Execution
The two important audit work that takes place in this phase are:
1. Substantive test (ST): substantive testing is of two (2) types:
a) Test of details: examples include observing year-end stock count, selecting sample(s) from the population of expense or asset items and inspecting the invoices/supporting documents for each sample, requesting 3rd party confirmation (bank, customer, vendor), recalculations of account items to test correctness.
b) Substantive Analytical Procedure (SAP): the auditor uses available data to develop expectation of account items and compare the expectation with figures in the TB.
2. Evaluate and communicate misstatements/exceptions: during the process of performing the ST, the auditor may identify material misstatements. They will discuss these misstatements with you before they propose an audit journal to correct them.
1.2. Reporting
Below are key reporting procedures. More audit journals may emanate from performing these procedures. For example, the subsequent event test may identify some items that were wrongly posted into 2023 and ought to have been posted into 2022.
Key reporting activities | |
1 | Going concern evaluation at reporting |
2 | Subsequent event test |
3 | Revised materiality |
4 | Litigation summary |
5 | Detailed FS Review |
6 | Management letter |
7 | Management representation letter |
8 | Concluding Analytical Procedure |
9 | Financial statements are signed by the Company |
10 | Audit report is signed by the Auditor |
2. Top preparatory steps (No.4 is very important!)
S/N | Preparatory steps |
1 | Discuss and agree the planned commencement date, timelines, key milestones. |
2 | Clarify if the audit team would come in for an interim audit before the year ends to reduce the audit work at year end. Agree interim and year-end audit dates. |
3 | Ensure that the auditors send their audit request 1-2 weeks ahead of the agreed commencement date(s). This will give you ample time to prepare ahead. |
4 | Whether or not the audit request is received, at the minimum, ensure you have the |
5 | A well-prepared schedule is complete, accurate and agrees with the respective balance in the trial balance. For example, a loan schedule shouldn’t only be complete and accurate, it must also agree with the respective figures on the trial balance! See google drive for samples of some schedules. |
6 | Carefully review General Ledger, Mapped Trial balance and well-prepared schedule (GMWS) vis-à-vis the bills, invoices, and receipts (as applicable) to ensure they’re correct. Make adequate corrections where appropriate. |
7 | Once the GMWS are ready (including the supporting documents – bills, invoices, and receipts), also prepare the other documents itemized in the section 3 below. |
8 | Plan to send the GMWS to the auditors 1-2 weeks ahead of the commencement date. If other documents are also available, they can be sent along with the GMWS. To make the process more orderly, you can send the documents in few batches – maybe 3-4 batches. |
9 | Inform everyone in the Company ahead of the commencement of the audit. |
10 | Ahead of the date that the audit team will be physically available, ensure the office space they will be working from has been cleaned up and well prepared. |
Examples of schedules (list is not exhaustive. Few sample schedules have been uploaded to the google drive)
ü Property, plant, and equipment schedule (including depreciation schedule) ü Fixed asset register ü Inventory schedule ü Trade receivables & payable schedule ü Expected credit loss schedule ü Bank reconciliation statement ü Investment schedule ü Loan schedule (including interest expense computation)
| ü WHT and VAT schedules ü PAYE computation schedule ü Accrual schedule ü Revenue schedule (for each source of revenue) ü Asset retirement obligation schedule ü PPE impairment schedule ü Prepayment schedule ü Current & deferred taxes computation schedule ü Full year payroll
|
3. Proactive preparation of documents.
Here are some preparatory documents associated with each audit phase. Note that the list is not exhaustive.
3.1. Planning
S/N | Work area | Preparatory document or activities to perform |
1 | Engagement risk assessment | ü Memorandum and articles of association ü Group structure (if a group audit) ü The ultimate owner (a person and not an entity) of the Company ü Shareholding/ownership structure ü Governance structure ü List of key management staff and brief profile (including Directors) ü List of related parties and nature of relationship |
2 | Team selection | ü Mapped trial balance (this can help them assign team members) ü Prior year audited FS (if the auditors are new) – PDF and excel format. |
3 | Understanding the entity, its industry and environment | ü All items listed under 1 & 2 above. ü General ledger ü Latest Organogram ü Approved budget for the year under review ü Monthly management accounts ü All Company Policies (both financial and otherwise) e.g., HR Policy, Code of conduct, risk management policy, Procurement policy etc. ü Risk register ü Standard Operating Procedure (SOP), if available ü Approval matrix ü All significant contracts (“that may be of interest to the auditors”) ü All correspondences with regulatory authority (“that may be of interest to the auditors”) ü Minutes of meetings – Board and management meetings ü Internal audit plan, copies of all internal audit reports issued during the period (including IT audit). ü Summary of ongoing litigation ü All bank statements ü Key contact person (including someone from the IT Dept) |
4 | Audit team planning meeting
| All items listed above be useful for them ahead of the meeting. |
5 | Planning meeting with the client | All items listed above be useful for them ahead of the meeting. |
6 | Materiality | All items listed above will provide the required understanding. |
7 | Understanding (entity level) internal control.
| ü All Company’s policies ü Documentary evidence that the policies were complied with. For example, if the HR policy states that candidates must be interviewed, there should mail trails evidencing invites for interview and actual performance of that interview. |
8 | Control testing | ü Supporting documents e.g., invoices, mail correspondences. You may not know the particular item they will pick as their sample to test your controls, but ensure you have a process for safely and orderly keeping your supporting documents. ü Schedules for each of all your account items. ü Evidence (if available) that a control was performed. |
9 | Analytical procedure (AP) | GMWS |
10 | Going concern at planning | ü Cash flow forecast covering 18 months after the reporting date ü Going concern assessment (engage your auditor for a template) |
11 | Inherent risks and identify material FS items | ü Mapped trial balance ü Prior year audited FS (if a new auditor). They would prefer to have this in excel so that they can understand how the TB flows into the FS. |
3.2. Execution
S/N | Work area | Preparatory documents and activities |
1 | Substantive testing | ü GMWS ü Supporting documents (invoices, receipts, mail correspondences etc.). ü Invite auditors to perform year-end inventory and cash count. It’s better to first notify them 1 month before the year end to give them ample time to prepare ahead. The notification should state the required no. of staff, location(s). Afterwards, send an invitation 1-2 weeks before the year end and plan travel, transportation, and accommodation logistics. ü Immediately after the year end, request for the auditor to share their preferred sample of circularization letters with you.
Remember, before giving your auditor the GMWS, you must carefully review! |
3.3. Reporting
S/N | Key planning activities | Preparatory documents and activities |
1 | Going concern evaluation at reporting | See above under documents to be provided at planning |
2 | Subsequent event test | ü Trial balance and General ledger for the subsequent period. For example, if your year end is 31 December 2021 and the auditors are performing the subsequent event procedure on the 15 July 2022, prepare GL from 1 January 2022 to 30 June 2022. ü Board & Mgt minutes of meeting after year end. |
3 | Revised materiality | ü Audited trial balance (TB) ü The auditor may wish to request additional supporting documents depending on the revised materiality. |
4 | Litigation summary | Schedule of litigation summary showing an evaluation of each legal case. The evaluation should conclude on whether each legal case is a provision or a contingent liability or no exposure. |
5 | Detailed FS Review | ü Company secretary/internal legal counsel should review the Directors’ Report before inclusion in Annual Report. ü Draft financial statements after passing all agreed audit adjustments. Subsequently updated for any review comments raised by the auditors. ü Review audited FS before signing. Auditors can also make mistakes |
6 | Management letter | Discuss management letter points with auditors as some may not be valid points. Provide responses to all management letter points in a professional manner. |
7 | Management representation letter | This would usually be sent by the auditor. You should review it thoroughly in case there are any specific items that ought to be excluded based on your understanding. Discuss and clarify such items with the auditors before signing by the appropriate parties. |
8 | Concluding Analytical Procedure | The audited TB. The auditor already has this. |
4. Further tips to make the process smoother
S/N | Tips |
1 | Start preparing early. You can make use of prior year’s audit request as a guide to know further specific items they may need. |
2 | Do not wait for the year-end to start the reconciliation process. Practice reconciling your books every month or quarter to ensure the financial reporting is as accurate as possible. |
3 | Send out circularisation letters (banks, solicitors, vendors, customers etc.) early enough before commencement date or immediately after year end. |
4 | You do not need to have everything 100% ready before the audit starts. A key starting point is to fix your GMWS as explained above. |
5 | While preparing and reviewing your GMWS, pay close attention to areas where audit adjustments were passed during the previous audit. Also, pay attention to management letter points raised during prior year audit. |
6 | When the audit commences, ensure you check in with the auditors at least once per week to understand the progress and any bottleneck that may be slowing down the audit. |
7 | Ensure that the auditors send a list of outstanding audit request at least once every week (e.g., every Wednesday evening). |
8 | Focus more on only material issues. Do not waste too much time on issues that are not material. (See google drive of sample on determining materiality). |
9 | Before preparing the FS, you can request if the auditor has a preferred template or an illustrative guide. The Big 4 audit firms have an annual Illustrative FS which you can use as a guide to prepare your Company’s FS. |
10 | Discuss and agree all audit adjustments with the auditor before they are passed. |
11 | Review all management letter points and discuss them with the auditors before such points are presented to the management or to those charged with governance. This will enable you avoid “negative surprises” |
12 | Close-out meeting with the auditors where you discuss ways to improve for the next audit. |
This article is also available in a PDF document. Click here to download: drive.google.com
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