Module 4 - Introduction to Performance Audit_4C

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To account for the time value of money, project appraisal methods can use discounted cashflows (DCF). Capital has an assumed cost. It must be borrowed or used from reserves in which the cost is the opportunity cost of not doing something else with it (like investing it). The further ahead a cashflow occurs (or is predicted to occur), the lower its relative value. The cost of capital has a cumulative effect. For example, suppose the assumed cost of capital is 10%. We can calculate discounted cashflow factors. The formula is: Discount factor = 1/(1 + discount rate) years In this case, the discount rate is 10% or 0.1. Discount factors are as follows: Year Discount factor 0 1.000 1 0.909 2 0.826 3 0.751 4 0.683 5 0.621 (Note: These discount factors are available as tables online or in published form, and in an exam you would not be expected to calculate them.) We use these factors to discount future cashflows to the present value. 1 LEK today is worth 1 Lek. 1 LEK in a year’s time has the same value as 0.909 LEK today. I could invest 0.909 LEK today for a year and at the end I will have 1 LEK. We can use these factors with the information given in the Payback example. Year Discount factor Net cash inflow/(outflow) Discounted cashflow Cumulative discounted cashflow 0 1.000 (158) (158) (158) 1 0.909 18 16 (142) 2 0.826 41 34 (108) 3 0.751 65 49 (59) 4 0.683 85 58 (1) 5 0.621 85 53 52 In this case we can see the project does not have a positive cumulative discounted cashflow until just after the end of year four. Our Payback period on this basis is just over four years. It is longer than our previous calculation because we have discounted the cashflows, the further they are in the future, the greater the amount of discount. 85,000,000 LEK received in five years’ time has the same value as 53,000,000 LEK received today. Financial ratios 48
Financial ratios may be used in performance auditing to analyse project information. In particular, the efficiency and profitability ratios studied in Module 3 may be useful for this purpose. Efficiency and profitability Operating Margin Surplus (or deficit) ÷ Revenue x 100 % Expense Margins Individual Expense ÷ Revenue x 100 % Return on Assets Surplus (or deficit) ÷ Assets x 100 % In these calculations, the revenues, expenses and assets relate solely to the project, programme or entity under review. As noted in sections 4A.2 and 4A.3, auditors must remain alert to the importance of audit risk and materiality at all stages of the engagement, while quality assurance arrangements, including supervision, are also essential throughout. Audit documentation is likewise completed at all stages and is described below in section 4C.2. There is an important difference between information and evidence. Information becomes evidence when it is used in support of a condition. This requires the information to be analyzed and evaluated using acceptable logical and numerical techniques to ensure conclusions are valid. 4C.1: Reflection Which, if any, is the most important dimension of performance: efficiency, economy, or effectiveness? Which is the hardest dimension to measure: efficiency, economy, or effectiveness? As the auditor, how do you know when you have satisfied the requirement for sufficiency of information? 4C.2 Audit Documentation Standard 2330 – Documenting Information describes the requirements for internal auditors to maintain records during an engagement. Documentation must be available to support the results and conclusions recorded in the report. Much of the standard focuses on access and retention. Internal auditors must document sufficient, reliable, relevant, and useful information to support the engagement results and conclusions. 2330.A1 The chief audit executive must control access to engagement records. The chief audit executive must obtain the approval of senior management and/or legal counsel prior to releasing such records to external parties, as appropriate. 2330.A2 The chief audit executive must develop retention requirements for engagement records, regardless of the medium in which each record is stored. These retention 49
Page 1 and 2: 4C. Performing a Performance Audit
Page 3 and 4: Direct •Evidence gathered directl
Page 5: Payback The concept of payback is s
Page 9 and 10: Testimonial Evidence - be alert to

Module 4 - Introduction to Performance Audit_4C

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