Measurement and Review Of the Entity Financial Performance

generally accepted accounting standards also require auditors to obtain an understanding of the measurement and review of the entitiy's financial performance, including both internal and external measures. Such measures might include :

1. key ratios and operating statistics
2. key performance indicators
3. employee performance measures and incentive compensations plans
4. industry trends
5. the use of forecast, budgets, and variance analysis
6. analyst reports and credit rating reports

a company might use variety of financial and nonfinancial measures to monitor performance. Today, many companies measures the efficiency of the manufacturing process by comparing the quantity of raw material used to the quantity of finished goods, and material and labour variencies. In addition, it might monitor the effectiveness of the manufacturing process using quality control statistics or measures of the amount of rework required to meet standards. This informations is essential for developing a knowledgeable perspective about reported amounts for inventory and cost of sales.

Many performance measures, such as those described above, are produced by the entity's information system. If management asumes that data used for reviewing the entity's performance are accurate without having a basis of that assumption, error may exist in the information, potentially leading management (or the auditors using the same information) to incorrect conclusions about performance. If the auditors uses management's performance measures to form an audit conclusions(e.g., in performing analytical procedures), he or she should consider the realibility of the informations system that produced the measure and wether the measure is sufficienly precise to detect material misstatement.

management and auditors use performance measure informations in different ways. When reported measures differ from management's expectations, management may take corrective action to improve the entitys performance. For example, poor inventory turnover might cause a company to to offer more attractive pricing in order to sell inventory. However, the audtor should consider whether a deviations in performance measures might indicated a risk of mistatement in underlying financial informations. A decline in inventory turnover might mean the certain manufacturing cost are being capitalized as part of inventory rather than being expensed. Deviations from expected performance measures are critical when asessing in inherent risk associated with financial statement assertions.  

Limitations of an audit

A financial statement audit is subject to a number of inherent limitations. One constraint is that the auditor works within fairly restrictive economic limits. Following are two important economic limitations.

Reasonable cost. A limitations on the cost of an audit results in selective testing or sampling, of the accounting records and supporting data. In addition, the auditor may choose to test internal controls and may obtain assurance from a well functioning system of internal controls.

Reasonable lenght of time. the auditor's report on many public companies is usually issued three or five weeks after the balance sheet date. This time constraint may affect the amount of evidence that can be obtained concerning events and transactions after the balance sheet date that may have an effect on the financial statements. Moreover, there is a relatively short time period available for resolving uncertaintes existing at the statement date.

Another significant limitations is the established accounting framework for preparing financial statements. Following are two important limitations associated with the established accounting framework.

Alternative accounting Principles. Alternative accounting principles are permitted under GAAP. Financial statement users must be knowledgeable about a company's accounting choices and their effect on financial statements.
Accounting Estimates. Estimates are an inherent part of the accounting process, and no one, including auditors, can foresee the outcome of uncertainties. Estimate range from the allowance for doubtfull accounts and an inventory obsolescence reserve to impairment tests of fixed assets and goodwill. An audit can not add exactness and certainly to financial statements when these factors do not exist.

Auditing defined

The term auditing is used to described a broad range of activities in our society. The following broad definition of auditing identifies a number of common attributes of most modern auditing activities. The report of the Committee on Basic Auditing Concept of the American Accounting Association defines audit as :
A systematic process of objectively obtaining and evaluating evidence regarding assertion about economic actions and events to ascertain the degree of correspondence between those assertion and established criteria and communicating the result to interested users.

AUDIT PROCEDURES

AUDIT PROCEDURES ARE THE METHODS OR TECHNIQUE THE AUDITOR USES TO GATHER AND EVALUATE AUDIT EVIDENCE. THE AUDITORS PERFORMS AUDIT PROCEDURES TO ACCOMPLISH THE FOLLOWING OBJECTIVES :

1. To obtain an understanding of the entity and its environment, including its internal control, to asses the risk of material misstatement at the financial statement level and at the level (risk assessment procedures).
2. To test the operating effectiveness of control in preventing or detecting material misstatement at the assertions level (test of control). Test of control are required when the auditor plans to assess control risk below the maximum and below the maximum and develop an audit strategy that assumes the operating effectiveness of internal control.
3. To support an assertions or detect material misstatement at the assertions level (substantive test). The auditor plans and performs substantive test that are responsive to assessed risk.