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4 Types of Audit Approaches

Auditing is an invaluable tool used to assess the accuracy and reliability of financial information.

There are various types of audit approaches that can be used to evaluate the accuracy of financial statements and other financial documents.

This article will discuss four of these audit approaches, which include:

  1. Substantive procedures: This approach involves testing the individual transactions and account balances to determine if they are recorded accurately. It focuses on gathering evidence to support the amounts and disclosures in the financial statements.
  2. Balance sheet approach: This approach focuses on auditing the balance sheet accounts, such as cash, accounts receivable, and inventory. It aims to ensure that these accounts are fairly presented and accurately reflect the financial position of the company.
  3. System-based approach: This approach involves evaluating the internal controls and accounting systems in place within the organization. It aims to identify any weaknesses or deficiencies in the system that could lead to errors or fraud.
  4. Risk-based approach: This approach focuses on identifying and assessing the risks associated with the financial statements. It involves understanding the business and industry in which the company operates and determining the areas of highest risk. The audit procedures are then tailored to address these specific risks.

Key Takeaways

  • Substantive Procedures Audit Approach focuses on testing significant transactions and verifying reliable supporting documents.
  • Balance Sheet Audit Approach prioritizes testing balance sheet items over income statement transactions and assesses the main financial assertions of existence, valuation, right, and obligation.
  • System Based Approach emphasizes the assessment and validation of internal controls, separate from the substantive-based approach.
  • Risk-based Audit Approach assesses risk areas and potential material misstatements, reducing audit risks and workload by allocating less time to areas with lower risks.

Audit Approaches

Audit approaches are strategies used by auditors to conduct audits in an effective and efficient manner. The chosen approach depends on various factors which include the client’s nature and industry, scope of engagement, adequacy of system controls, and level of cooperation received.

A commonly used general audit approach is the undisclosed test audit, which allows the auditor to gain an understanding of the client’s system and processes.

Compliance audits are also used, which involve the auditor examining the client’s system and processes to ensure they comply with regulations and standards.

Control self-assessment is an approach which involves the client assessing the effectiveness of their internal controls and procedures.

Lastly, internal control audits are used to evaluate the client’s internal control system and to identify any weaknesses.

All of these audit approaches are used to ensure the accuracy and reliability of financial information.

Substantive Procedures Audit Approach

Substantive Procedures is an audit approach that focuses on testing significant transactions and verifying reliable supporting documents. This audit approach is used when financial reporting systems or internal controls are unreliable.

Auditors do not test the entity’s internal controls on financial reporting; instead, they focus on large or material transactions. To ensure compliance with accounting standards and framework, auditors select significant transactions and check for reliable supporting documents.

While this approach requires more resources to test a large number of transactions, it helps minimize risks not detected by internal controls.

Balance Sheet Audit Approach

The balance sheet audit approach focuses on ensuring the accuracy of the entries in the statement of financial position. Auditors prioritize testing balance sheet items over income statement transactions since it is unlikely that the transactions in the income statements are materially misstated if the items or accounting balances in the statement of financial position are correct.

The main financial assertions assessed in balance sheet items are:

  1. Existence
  2. Valuation
  3. Right
  4. Obligation

This audit approach is useful when a company has just started its business, with large balance sheet items and fewer transactions. The auditors should have a good understanding of the accounting principles and the related assertions for each balance sheet item. Auditors must also be aware of the risks associated with each balance sheet item and must be able to identify any potential misstatements.

The audit approach for balance sheet items should be tailored to the specific industry and the company’s financial statements.

System Based Approach

The system-based approach to auditing emphasizes the assessment and validation of internal controls to ensure the accuracy of financial reporting. This approach is distinct from the substantive-based approach, which does not test the client’s internal control system.

In the system-based approach, auditors first evaluate the client’s internal control system based on information from management. This is followed by a full understanding of the internal control over financial reporting. Once the internal control is deemed strong, auditors then test and validate the internal control.

Substantive testing is also done, though with fewer transactions compared to the substantive approach. This approach allows auditors to identify and address any risks that could potentially lead to misstatements in financial reports.

Risk-based Audit Approach

Risk-based audit is a method of auditing that assesses risk areas and potential material misstatements to reduce audit risks and minimize workload. It is a commonly used approach by auditors and is designed to meet objectives. Auditors understand the client’s business, environment, and internal control to identify areas of concern.

The process involves:

  1. Understanding the client’s business, environment, and internal control.
  2. Assessing risk areas and potential material misstatements.
  3. Designing an auditor’s program and resources to detect these risks.
  4. Allocating less time to areas with lower risks.

The purpose of the risk-based audit approach is to identify any potential risks that could lead to misstatements or inaccuracies in the financial statements. The auditor then focuses on areas that are more likely to have issues or material misstatements. The approach also helps to minimize workload and ensure that objectives are met. It also allows auditors to focus on areas that are more important and have a higher risk of misstatements.

Conclusion

The four audit approaches are important tools for auditors to ensure the accuracy of financial statements.

  • Substantive procedures audit approach focuses on the accuracy of account balances and transactions.
  • Balance sheet audit approach looks at the financial statements as a whole to identify any misstatements.
  • System based approach evaluates accounting systems to detect any potential financial misstatements.
  • Risk-based audit approach assesses the risk of material misstatement and develops audit procedures to address those risks.