S4: Understanding the IT environment of the entity.

S4: Understanding S4: Understanding the IT environment of the IT environment of

the entitythe entity

Session objectives Session objectives Defining contours of financial accounting in Defining contours of financial accounting in

an IT environment and its characteristicsan IT environment and its characteristics Assessing the impact of IT on financial auditAssessing the impact of IT on financial audit Identifying controls in IT systemsIdentifying controls in IT systems Explaining objective and scope of Financial Explaining objective and scope of Financial

Audit in IT environmentAudit in IT environment Checking effectiveness of controlsChecking effectiveness of controls Designing audit proceduresDesigning audit procedures Explaining the importance of electronic Explaining the importance of electronic

documentation Gdocumentation G

Financial Audit in an IT Financial Audit in an IT environmentenvironment

The Auditing Standards of the The Auditing Standards of the Comptroller and Auditor General of Comptroller and Auditor General of India require thatIndia require that ““Where accounting or other information Where accounting or other information

systems are computerized, the auditor systems are computerized, the auditor should determine whether internal should determine whether internal controls are functioning properly to controls are functioning properly to ensure the integrity, reliability and ensure the integrity, reliability and completeness of the data.” Gcompleteness of the data.” G

Contours of Financial Contours of Financial Accounting in IT Accounting in IT

EnvironmentEnvironment Financial Accounting software and Financial Accounting software and

hardware of the entityhardware of the entity Other business Application Systems of the Other business Application Systems of the

entityentity e – Commerce, EDI, EFT, Office Automation e – Commerce, EDI, EFT, Office Automation

systems, ATMsystems, ATM Purchase Accounting systemPurchase Accounting system Inventory Control systemsInventory Control systems Pay roll systemsPay roll systems Accounts receivables and payables systems Accounts receivables and payables systems

Controls and risks in the IT environment of Controls and risks in the IT environment of the entity. the entity.

Management and OrganisationManagement and Organisation People ManagementPeople Management Change and Technology Change and Technology

ManagementManagement Focus on best practicesFocus on best practices SecuritySecurity OutsourcingOutsourcing Data ManagementData Management

Contours of Financial Contours of Financial Accounting in IT Accounting in IT Environment IIEnvironment II

Characteristics of IT Characteristics of IT SystemsSystems

Concentration of functions and knowledgeConcentration of functions and knowledge Concentration of computer programs and data Concentration of computer programs and data Absence of input documentsAbsence of input documents Lack of visible transaction trailLack of visible transaction trail Lack of visible outputLack of visible output Accessibility of data and programsAccessibility of data and programs – Risk – Risk

involvedinvolved Consistency of performanceConsistency of performance Vulnerability of data and program storage Vulnerability of data and program storage

mediamedia

Impact of IT on Financial Impact of IT on Financial AuditAudit

Financial Audit Objective in an IT Financial Audit Objective in an IT Environment – Changed Risk PerceptionEnvironment – Changed Risk Perception

Understanding of system essential for Understanding of system essential for Planning Planning

Identifying Internal Controls in an IT Identifying Internal Controls in an IT Environment a must for auditEnvironment a must for audit

Changed data retrieval methods and Changed data retrieval methods and Substantive Tests in auditSubstantive Tests in audit

Use of Advanced Auditing TechniquesUse of Advanced Auditing Techniques CAATs, Simulation, Test DataCAATs, Simulation, Test Data

Identifying controls in an IT Identifying controls in an IT system Isystem I

Controls reflect the policies, procedures, Controls reflect the policies, procedures, practices and organizational structures practices and organizational structures designed to provide reasonable assurance designed to provide reasonable assurance that the intended objectives of the entity will that the intended objectives of the entity will be achieved. be achieved.

They ensure effectiveness and efficiency of They ensure effectiveness and efficiency of operations, reliability of financial reporting operations, reliability of financial reporting and compliance with the rules and and compliance with the rules and regulations. regulations.

However, computer systems are efficient only However, computer systems are efficient only if they function in the manner they are if they function in the manner they are designed to and the controls provided are designed to and the controls provided are effective. effective.

Identifying controls in an Identifying controls in an IT System IIIT System II

Thus it is important for the Auditor to Thus it is important for the Auditor to verify that not only adequate controls verify that not only adequate controls exist, but that they also function exist, but that they also function effectively. effectively.

Such controls should also be Such controls should also be commensurate with the risk assessed so commensurate with the risk assessed so as to reduce the impact of identified as to reduce the impact of identified risks to acceptable levels.risks to acceptable levels.

Objectives of computer Objectives of computer controls controls

Achieving effective organizational control over Achieving effective organizational control over functions related to data processing by clearly functions related to data processing by clearly defining organizational objectivesdefining organizational objectives

Achieving effective management control over Achieving effective management control over development of data processing resources in development of data processing resources in conformity with organizational objectivesconformity with organizational objectives

Adopting practices related to data processing Adopting practices related to data processing activities in accordance with statutory activities in accordance with statutory requirements and prescribed administrative requirements and prescribed administrative proceduresprocedures

Adhering to policies, standards and procedures Adhering to policies, standards and procedures in respect of all data processing functionsin respect of all data processing functions

Assuring efficiency and effectiveness of the data Assuring efficiency and effectiveness of the data processing systems geared towards processing systems geared towards achievement of the desired objectives.achievement of the desired objectives.

General controlsGeneral controls General controls are controls over General controls are controls over

data centre operations, data centre operations, system software acquisition and maintenance,system software acquisition and maintenance, access security, and access security, and application system development and application system development and

maintenancemaintenance General Controls create the environment in General Controls create the environment in

which the application systems and application which the application systems and application controls operate e.g.controls operate e.g. IT policies, standards, and guidelines IT policies, standards, and guidelines

pertaining to IT security and information pertaining to IT security and information protection, application software development protection, application software development and change controls, and change controls,

segregation of duties, service continuity segregation of duties, service continuity planning, IT project management, etc.planning, IT project management, etc.

Application ControlsApplication Controls

Application controls pertain to Application controls pertain to specific computer applications and specific computer applications and include controls that help to ensureinclude controls that help to ensure proper authorization, proper authorization, completeness, completeness, accuracy and validity of transactions, accuracy and validity of transactions, maintenance; and maintenance; and other types of data inputother types of data input

Application controlsApplication controls

Examples include Examples include system edit checks to help prevent possible system edit checks to help prevent possible

invalid inputsinvalid inputs system-enforced transaction controls that system-enforced transaction controls that

prevent users from performing transactions prevent users from performing transactions that are not part of their normal dutiesthat are not part of their normal duties

the creation of detailed reports and the creation of detailed reports and transaction control totals that can be transaction control totals that can be balanced by various units to the source data balanced by various units to the source data to ensure that all transactions have been to ensure that all transactions have been posted completely and accurately. posted completely and accurately.

Financial Audit in an IT Financial Audit in an IT environmentenvironment

The overall objective and scope of an audit The overall objective and scope of an audit remains same in an IT environment. remains same in an IT environment.

The processing, storage, retrieval and The processing, storage, retrieval and communication of financial information changes, communication of financial information changes, which may affect the accounting and internal which may affect the accounting and internal control systems employed by the auditee control systems employed by the auditee organization. organization.

Thus IT environment may affect: Thus IT environment may affect: the procedures followed by the auditor in obtaining a the procedures followed by the auditor in obtaining a

sufficient understanding of the accounting and sufficient understanding of the accounting and internal control systemsinternal control systems

the auditor’s evaluation of inherent risk and control the auditor’s evaluation of inherent risk and control risk through which the auditor arrives at the risk risk through which the auditor arrives at the risk assessmentassessment

the auditor’s design and performance of tests of the auditor’s design and performance of tests of control and substantive procedures appropriate to control and substantive procedures appropriate to meet the audit objectivemeet the audit objective

Financial Audit in an IT Financial Audit in an IT environmentenvironment

While determining the effect of the IT While determining the effect of the IT environment on the financial audit, the environment on the financial audit, the auditor should evaluate,auditor should evaluate,

the extent to which the IT environment is used the extent to which the IT environment is used to record, compile and analyze accounting to record, compile and analyze accounting information;information;

the system of internal control in existence in the system of internal control in existence in the auditee organization with regard to the auditee organization with regard to

flow of authorized, correct and complete data to the flow of authorized, correct and complete data to the processing centerprocessing center

processing, analysis and reporting tasks processing, analysis and reporting tasks undertaken in the installationundertaken in the installation

the impact of computer-based accounting system the impact of computer-based accounting system on the audit trail that could otherwise be expected on the audit trail that could otherwise be expected to exist in an entirely manual systemto exist in an entirely manual system..

To check effectiveness of To check effectiveness of controlscontrols

Effectiveness of controls over the information Effectiveness of controls over the information technology processes that have a direct impact technology processes that have a direct impact on the processing of financial information on the processing of financial information could be judged by the following procedures:could be judged by the following procedures: determine the scope of audit analysis of the determine the scope of audit analysis of the

information technology processes by identifying information technology processes by identifying how they support important business processes how they support important business processes and the processing of financial information;and the processing of financial information;

obtain background information about the obtain background information about the auditee organization’s IT environment, auditee organization’s IT environment, including information about and applications including information about and applications supporting the critical business processes, supporting the critical business processes, together with the underlying platforms and together with the underlying platforms and those to which they are networked;those to which they are networked;

To check effectiveness of To check effectiveness of controlscontrols

Conduct a walk-through of those information Conduct a walk-through of those information technology processes deemed to have a technology processes deemed to have a direct and important effect on the processing direct and important effect on the processing of financial information to confirm the of financial information to confirm the auditor’s understanding of the process design auditor’s understanding of the process design and related controls; andand related controls; and

Based upon the understanding of the Based upon the understanding of the information technology processes, evaluate information technology processes, evaluate the effectiveness of the design of each of the the effectiveness of the design of each of the major information technology processes and major information technology processes and related internal controls. related internal controls.

To evaluate reliability of To evaluate reliability of accounting and controlsaccounting and controls

The auditor should check whether the systems: The auditor should check whether the systems: ensure that authorised, correct and complete data is ensure that authorised, correct and complete data is

made available for processing;made available for processing; provide for timely detection and correction of errors;provide for timely detection and correction of errors; ensure that in case of interruption in the working of ensure that in case of interruption in the working of

the IT environment due to power, mechanical or the IT environment due to power, mechanical or processing failures, the system restarts without processing failures, the system restarts without distorting the completion of the entries and records;distorting the completion of the entries and records;

ensure the accuracy and completeness of output;ensure the accuracy and completeness of output; provide adequate data security against fire and other provide adequate data security against fire and other

calamities, wrong processing, frauds etc.;calamities, wrong processing, frauds etc.; prevent unauthorized amendments to the programs; prevent unauthorized amendments to the programs;

andand provide for safe custody of source code of application provide for safe custody of source code of application

software and data files.software and data files.

Audit proceduresAudit procedures The auditor should consider the IT The auditor should consider the IT

environment in designing audit procedures to environment in designing audit procedures to reduce audit risk to an acceptably low level. reduce audit risk to an acceptably low level. He should check whether: He should check whether: adequate procedures exist to ensure that adequate procedures exist to ensure that

the data transmitted is correct and the data transmitted is correct and complete; andcomplete; and

cross-verification of records, reconciliation cross-verification of records, reconciliation statements and control systems between statements and control systems between primary and subsidiary records do exist and primary and subsidiary records do exist and are operative and that accuracy of computer are operative and that accuracy of computer compiled records is not assumed.compiled records is not assumed.

The methods of applying audit procedures to The methods of applying audit procedures to gather evidence may be influenced by the gather evidence may be influenced by the methods of computer processing. methods of computer processing.

Audit proceduresAudit procedures

The auditor can use manual audit procedures, The auditor can use manual audit procedures, or computer-assisted audit techniques, or a or computer-assisted audit techniques, or a combination of both to obtain sufficient combination of both to obtain sufficient evidence.evidence.

The IT Systems can help the auditor in using The IT Systems can help the auditor in using analytical procedures (for analyzing ratios and analytical procedures (for analyzing ratios and trends, identifying unusual items, etc.) and in trends, identifying unusual items, etc.) and in using sampling techniques and generating using sampling techniques and generating random samples. IT Systems can facilitate the random samples. IT Systems can facilitate the application of Monetary Unit Sampling, which is application of Monetary Unit Sampling, which is widely used in financial audit. widely used in financial audit.

The auditor can also extract the relevant The auditor can also extract the relevant records required by him using IDEA or other records required by him using IDEA or other package. package.

DocumentationDocumentation

The auditor should document the audit The auditor should document the audit plan, the nature, timing and extent of audit plan, the nature, timing and extent of audit procedures performed and the conclusions procedures performed and the conclusions drawn from the evidence obtained.drawn from the evidence obtained.

If audit evidence is in the electronic form, If audit evidence is in the electronic form, the auditor should satisfy himself that such the auditor should satisfy himself that such evidence is adequately and safely stored evidence is adequately and safely stored and is retrievable in its entirety as and and is retrievable in its entirety as and when required.when required.

The authenticity of the audit evidence The authenticity of the audit evidence should be ensured beyond all reasonable should be ensured beyond all reasonable doubt.doubt.