India, 21 March 2022— Auditing is to scrutinize the entity’s financial records and report whether the financial statements are correct. It comforts the shareholders that the financials are free of material misstatements or errors. Let’s see the different types of audits.

Different Types of Audits:

1. Statutory Audit

2. Internal Audit

3. Bank Audit

4. Appointed as an auditor for a specific purpose like Stock Audit

How are audits conducted?

Audits are performed based on understanding the nature and risk of material misstatement related to GL account balances. For example, assume that we are auditing the Fictitious assets in the financials of XYZ Inc. Then, we need to look into the below considerations:

1. What is the meaning of fictitious assets?

Fictitious assets are unreal assets that do not have any physical existence. Said differently, it comprises the expenses amortized over a couple of years based on their benefits outflowing.

2. Risks relating to this fictitious asset

The entity does not record the asset at correct amounts and does not relate to the entity (Rights Assertion)

3. What’s the entity policy regarding the amortization of fictitious assets? 

For example, an entity has a policy of recording the expenditure as fictitious assets, which benefits for more than a year and is higher than $10,000.

Understanding the above three aspects help the auditor to plan and perform substantive testing. The preliminary step in planning and performing testing of any account balances is to determine the Materiality, performance materiality, and Immaterial Variance. Let’s understand each of these.

Materiality: It’s a benchmark balance that helps the audit team check if any amount is worth auditing. The audit team determines this based on Professional judgment and Specific Account Balance (Standard to determine Materiality). 

Note: Standard is determined based on the nature of the company being audited. For example, the entity is financed majorly by Equity. Then Audit team chooses to pick up Equity share capital as Standard GL, and a percentage of it is considered as Materiality.

Performance Materiality: Performance materiality is a level below Materiality. This number acts as a checkpoint for auditors to ensure that the undetected misstatements if combined with detected misstatements, do not exceed the Materiality.

How to calculate performance materiality: Performance materiality is calculated as a percentage of Materiality. The percentage to be applied depends on the history of errors or misstatements during the prior year and the auditor’s professional judgment.

Immateriality Variance: If the balance is very immaterial, the audit team need not worry about it, and does not require testing. The logic behind this is that even if there is some error or misstatement, that will not affect the auditor’s opinion on the financial statements of the entity being audited. 

Immaterial Variance can be calculated as 1%-3% of Materiality balance. This is not a rule. It depends on the auditor’s judgment, and the percentage can go up to 5%.

Conclusion: The audit is to perform testing of the financial records with proper preparation and planning. There are different audit categories, such as Statutorily Mandated audits, Audits required by the entity/management (Internal Audit), and bank audits. The first step in planning the audit is to calculate the Materiality, performance materiality, and immaterial Variance. The subsequent steps is to design and perform the substantive procedure by testing details of the transaction or analytical procedures, or both.

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