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How to do an effective External Audit?

What is external audit?

External auditors areindependent audit professionals who audit the financial statements of acompany, legal entity or organization. They are expected to express an opinionon whether an entity’s financial statements are free of material misstatementsand are a true and fair representation of actual financial position.


Audit phases:

Generally there arefour phases of audit:

  1. Planand design an audit approach.

  2. Performtests of controls and substantive tests of transactions.

  3. Performanalytical procedures and test of details of balances.

  4. Completethe audit and issue an audit report.



  1. Understandingobjectives and responsibilities for the audit.

  2. Dividefinancial statements into cycles.

  3. Knowmanagement assertions about financial statements.

  4. Knowgeneral audit objectives for classes of transactions, accounts and disclosures.


Stepsinvolved in an audit:

  1. Obtainan Understanding of the Entity and Its Environment

  2. UnderstandInternal Controls and Assess Control Risk

  3. AssessRisk of Material Misstatement

  4. Testsof Control

  5. SubstantiveTests of Transactions

  6. AnalyticalProcedures

  7. Testsof Details of Balances


Althoughterminology may differ, auditors generally will consider the following assertions,separated into three categories:



  1. Occurrence    -          Transactions took place.

  2. Completeness   -              Transactions that should have beenrecorded have been recorded.

  3. Accuracy            -              Transaction amounts and other datahave been recorded appropriately.

  4. Cutoff                 -              Transactions have been recorded incorrect accounting period.

  5. Classification     -              Transactionshave been recorded in proper accounts.


Account balances

  1. Existence                      -        Assets, liabilities and equityinterests exist.

  2. Rights and obligations           -            The entity has rights to assetsand is obligated for liabilities.

  3. Completeness                        -            All assets, liabilities and equityinterests that should have been recorded have been recorded.

  4. Valuation and allocation  -           Assets,liabilities and equity interests are included and adjustments are recordedappropriately in the financial statements.


Presentation and disclosure

  1. Occurrence,rights and obligations   -      Disclosed transactions haveoccurred and pertain to the entity.

  2. Completeness                                                 -        Disclosures that should have beenincluded have been included.

  3. Classificationand understandability      -            Financial information is presentedand described appropriately, and disclosures are expressed clearly.

  4. Accuracyand valuation                          -              Information is disclosed fairlyand at appropriate amounts.


The auditor evaluates acompany’s risk of material misstatement by evaluating:


  • Inherentrisk (natural risk irrespective of internal controls). Some examples ofinherent risk considerations include: volume, complexity, susceptibility of anasset to theft, estimates, and industry circumstances.


  • Controlrisk (risk that the internal control system will not prevent or detect amaterial misstatement). Some factors that influence inherent risk can alsoimpact control risk (complexity, judgment required, susceptibility to fraud).Other control risks include the nature of operations, changes in operations andenvironmental factors.


Auditors perform twodifferent types of audit tests: tests of controls and substantive procedures.


  1. Tests of controls are designed to evaluate theeffectiveness of the internal control system in preventing or in detecting andcorrecting errors before they result in a material misstatement in the financialstatements. Tests may include:

  • awalkthrough, from beginning to end, of one or more transactions; and

  • selectingsamples of controls at a point in time, or over time, and observing orreperforming them to obtain evidence that they operate effectively.


  1. Substantive procedures are designed to detect materialmisstatements at the assertion level by testing the output from the financialreporting process. Procedures consist of:

  • testsof details, which may include inspection, observation, external confirmation,recalculation, and/or inquiry on a sample of transactions or accounts; and

  • Substantiveanalytical procedures, which may range from simple comparisons to complexanalyses using advanced statistical techniques. Examples may include analyzingfinancial trends over time, comparing financial ratios (e.g., gross margin percentages)to established expectations, and comparing financial and non-financialinformation (e.g., payroll costs and number of employees).




Note: Conducting an externalaudit varies from industry to industry and further it depends on the nature ofthe organization in which the audit is carried out. The above write up is onlya general glimpse of the essential audit steps to be kept in mind whileconducting an audit.

Post on: 30Aug, 2014 By Dhiraj Satnalika 3 comments


  1. Dhiraj

    Hi Karan.. Thanks for your interest and co-operation. You can mail me your post on support@satnalika.com. I will post the same on your behalf under your name. Thanks

    1. karan shaw

      Hi I want to post something about company law 2013... Please tell me how to post....

      1. Ruchika


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