Importance of Basic Audit Techniques and basic methods employed for securing information

Audit Techniques are the methods generally applied in the collection of evidences or securing information. They are the means available to an auditor on the application of which be can collect evidences from his clients. These techniques are not the evidences by themselves rather they are only means and methods to force technically the clients to produce the evidences and proof regarding the genuineness of a particular business transaction. Techniques are applied first; evidences are then collected as a result of the application of these techniques. If these techniques are not applied, the auditor may not be able to collect some of the evidences and the clients may hide them. In this case, the auditor may not be able to throw his professional light on the reliability of the accounting data.

Mautz has defined ‘Audit Techniques’ as “The expression ‘Audit techniques’ may be used to describe the basic methods of collecting evidences used by auditors, the technique in itself is not evidence; it supplies the evidence required by the auditor to inform him sufficiently on the subject so that he can give a professional opinion”.

Which technique should be applied at a particular time and situation, depends upon the auditor’s knowledge, experience, skill and judgment capacity. He cannot ‘smell’ out the errors in the records without applying audit techniques.

Ten Basic Techniques

The various basic techniques or methods of securing information may be listed as under:

1) Physical examination and count

2) Confirmation

3) Examination of authoritative documents

4) Re-computation

5) Retracing book-keeping procedures

6) Scanning

7) Inquiry

8) Examination of subsidiary records

9) Correlation with related information

10) Observation of pertinent activities and condition.

These techniques are discussed here in some detail:

Physical Examination & Count

Physical examination implies count, identification, and, to at least a limited degree, verification of genuineness and quality. No responsibility can be established for the auditor in regard to quality and genuineness because be cannot be expected to be an expert in every type of material. On the other hand, he cannot dredge responsibility by merely stating that he is not an expert. In fact, the real solution of the problem lies somewhere in between these two extremes.

Physical examination is known as eye-witness in Auditing. But it involves certain subsidiary ideas which require attention:

1)         First of all, it requires identification of the item being examined. It does little good to examine an inventory of purchased parts unless some can tell with reasonable accuracy what is being examined and can later relate it to the information in the accounting records. One must be convinced that he has examined the specific thing which he is supposed to be verifying.

2)         The auditor should try his best to distinguish quality of whatever be is examining. It is a difficult job for the auditor.

3)         Quantity should also be given consideration. Count is a part of physical examination. For example, one who is verifying the existence of three trucks, he must count and should not be content if he is shows but two.

4)         Physical examination tells nothing about the ownership of the thing. Hence additional consideration must be given to establish the fact of ownership.

Limitation of the technique of physical examination is that this technique is restricted to those assets which are either material or have some tangible evidence of existence. It is extremely useful in regard to cash, inventories, fixed property additions, and the like.

In many cases, this technique can be applied satisfactorily only if advance preparations have been made to get the items to be examined in position and condition for inspection. Material in transit, in process of manufacture, packaged or partially assembled goods may make effective examination and count impossible.

Confirmation

Confirmation consists of obtaining a written statement from someone outside the enterprise on a fact which that person is qualified to affirm. Properly applied, it is one of the useful techniques available to an auditor and supplies evidence of considerable reliability of some accounts. It may be applied to verify:

1) Accounts Receivable

2) Accounts Payable

3) Bank Balances

4) Contingent Liabilities

5) Inventory in Warehouse

6) Title to property

7) Advances to outside parties

8) Investments.

This technique is applied by writing letters to the parties concerned to confirm a particular amount. Obviously, it depends upon the reliability of the parties concerned and influence of the clients on the party concerned. The difficulty in applying this technique is that the outside parties are not under any legal obligation to supply any information to the auditor. The auditor has no relation with the outside party whereas the clients are elated with the party. They may not listen to the auditor but they may listen to their business relations. Therefore, as a matter of courtesy, the request for information should come not from the auditor but from the company. Another control that involves is this: that the answer to all requests should be sent directly to the auditor without any interference of the company in any way.

Examination of Original Documents

In modern business, almost every transaction is evidenced by a document of some king. Included in this idea of documentary evidence for transactions are purchases and sales invoices, cheques, remittance advices, insurance policies, contracts, stock certificates, guarantees, requisitions, purchase orders, receiving reports, and a host of specialised papers.

Business papers of this of type provide the original record of the given transaction and constitute the evidence of that transaction. Some of the examples are as follows:

1) Purchases invoices will be examined and compared with the purchase book;

2) Cancelled cheques will be examined and compared with the cheque register or cash disbursement book;

3) Petty cash tickets will be examined and compared with the record of petty cash disbursements.

It is practically not possible to examine all the documents due to audit expenses. Therefore, random sampling may be applied. Further, if the auditor is satisfied with the internal control system, he may reduce his work. If he gets errors and irregularities in the selected transactions, then he may increase his area of examination to a large number of transactions.

Re-computation

By ‘Re-computation’ we mean to compute or calculate again to verify accounting figures, where necessary. Generally, auditors are given tape-runs in support of the accounting figures. But the rule “never accept a client’s tape” is a very practical one and should never be broken by the auditor without recognition of the risk which follows.

Re-computation is at once the most simple and the most valid verification technique. It is complete in itself. Once the auditor proves the accuracy of a particular figure by his own calculation, he accepts he arithmetical accuracy without further question. The technique of re-computation may be applied to:

1) Footing of books of original entry

2) Ledger account balances

3) Depreciation and bad debt computation

4) Bonus calculation

5) Write offs of prepaid insurance and patents.

It should be noted that the technique of re-computation proves only arithmetical accuracy and nothing more. Other tests are required to establish the validity of component figures.

Retracing Book-Keeping Procedures

In this technique, the auditor has to repeat what has already been done by the accounts staff. The discover any errors which may have been made in such book-keeping procedures as posting from the book of original entry to the ledger, or in taking total balances, it is necessary for the auditor to repeat the particular procedure. This technique is applied in order to ensure that the accounts were correctly processed, posted and finally presented correctly on the financial statements. Errors noted during application of this technique are required to be rectified by the accounts staff. A record of errors observed should, however, be kept by the auditor and any abnormal feature should be reported to the management for the preventive action.

Scanning

To scan means to scrutinise or to examine point by point. In auditing, it refer to the critical study of an account, a book of original entry, or any other record or summary of information. This is said to be a technique which approaches the ‘sixth sense’ attributed to an auditor mistakenly. An experienced and alert auditor looks a given page and immediately conclude not only that something is peculiar but also state exactly where the trouble lies. However, there is nothing miraculous about such a diagnosis. The auditor is merely summoning up all his accounting knowledge and experience on that particular type of information to evaluate that which he sees as being either normal and ordinary or as being unusual and therefore subject to suspicion. His eyes stop itself if there is anything unusual. For example, a general ledger account for cash in most cases will receive one debit a month from the cash receipt book and one credit a month from the cash disbursements records. Thirteen credits in the space of a single year should arouse one’s interest as to what the necessity for the thirteenth item might be. In the same way a debit to cash from some source other than the cash receipts book would bear investigation.

Scanning is perhaps the most indefinite – audit technique commonly employed, and it is one which seldom gives rise to easily established evidence. In many cases it merely establishes the necessity for further verification of some other kind. Yet in the hands of an experienced man it is an extremely valuable tool and one never to be overlooked.

Inquiry

Inquiry consists of asking questions and of obtaining satisfactory answers to those questions. The answers range from formal statements in writing to casual conversational comments. Yet by a careful use of the questioning procedure one can learn a great deal about matters which might otherwise be obscure. The answer to a single question is seldom a reliable bit of evidence. The answers to several related questions may provide very satisfactory evidence if they are all reasonable and consistence.

It is not a good practice to allow those keeping the records to feel that an auditor is willing to rely on their unsupported statements. In this case they will not give careful and accurate replies.

Occasionally one is forced to obtain additional information by telephoned questions, but it should be 

apparent that such information is rarely subject to real verification. The man who earns himself a reputation as a “telephone auditor” does not have a particularly enviable rating among his fellow practitioners.

Examination of Subsidiary Records

In large organisation a good number of accounts are operated and they are controlled by “Control Accounts” techniques. These control accounts are supported by subsidiary ledger accounts. For example, Account Receivable Control is supported by Account Receivable Subsidiary Ledger. Accounts Payable Control is supported by Accounts payable Subsidiary Ledger. Selling Expense – Control is supported by selling Expense Subsidiary Ledger.

These subsidiary records should be checked by the auditor in order to ensure that the Control Accounts are correct. Control account figures should not be accepted without examining the corresponding subsidiary records. There may be a number of discrepancies, irregularities, wrong postings or castings in the subsidiary records and if this record is not checked in detail, the errors may pass undetected resulting in the Control accounts being inaccurate.

The subsidiary records may be checked on percentage of sample basis depending on the system or degree of satisfactory internal control system.

The subsidiary records may be checked on percentage or sample basis depending on the system or degree of satisfactory internal control system.

Correlation with Related Information

Within the double entry system of accounting, there is a great tendency for items in one place to relate to those in another. For example, there is generally a relationship between the amount of insurance expense for the year and the decrease in the unexpired insurance account balance. Similarly, there is relationship between the increase in the estimated uncollectible and the bad debt expense account. Auditors should continually be on the look-out for possibilities of exploiting such relationship. An asset account which is related to an expense account is not fully verified until that expense account has been reconciled with the asset in some way. The same is true of liability accounts such as accrued taxes and accrued interest.

The internal harmony or consistency of related accounts is certainly some evidence that accounts are free of at least mechanical errors, if no others.

Observation

During the course of a normal audit engagement, an auditor has a great many opportunities to exercise his powers of observation. He will examine and count portion of the inventory, probably take a tour of the plant, see the various employees at work, note the facilities for protection of company assets and records, and observe various phases of the internal control programme. At all times he should be alert to any activities or conditions pertinent to the reliability of the financial statement assertions. For example, while observing the inventory the may note damaged or obsolete stock. Similarly he may note that appropriate control procedures are neglected in the handling of cash.

Observation is perhaps the most general of all the basic audit techniques. It does not apply to specific verification problems in the way that confirmation or re-computation does, rather it is of some usefulness in almost all phases of the examination and should never be overlooked.