Transcript Information Systems

AUDIT
EVIDENCE
SECTION 5
Audit Evidence
• Relates to the third examination standard
• Sufficient appropriate audit evidence should be obtained by
such means as:
• To afford a reasonable basis to support the?
• Audit procedure must be both effective and efficient
• Who is responsible for the accuracy of the recorded
transactions prepared in accordance with GAAP?
• Who is responsible for the detection of error and fraud?
• The fairness of presentation of the F/S?
• The auditors need to accumulate sufficient appropriate audit
evidence
The Nature of Evidence
UNDERLYING ACCOUNTING DATA
Worksheets, Computations,
Reconciliations
+
=
SUFFICIENT APPROPRIATE
AUDIT EVIDENCE
CORROBORATING INFORMATION
Confirmations, Computation,
Analysis
• The underlying accounting data is indispensable as it
provides the basis for the client’s F/S
Evidence Matter for Tests of
Controls
• Tests of controls or compliance tests
• Second examination standard
• There should be a study and evaluation of those internal
controls on which the auditor subsequently relies
•
Four primary concerns
1. Was the specific control procedure actually
performed?
2. Was it performed properly?
3. By the appropriate person?
4. Throughout the period of reliance?
•
Two categories for tests of controls:
1. Document inspection
2. Inquiry and observation
• Remember the third examination standard:
• The auditor must obtain sufficient and appropriate
audit evidence to support the audit opinion
• The auditor employs substantive procedures to gather
evidence relating to transactions and balances
Sufficiency of Evidence
• Pertains to quantity
• Auditor’s judgment may be affected by:
• Materiality and Risk
• Economic factors
• Size and characteristics of the population
•
Materiality and Risk
•
Quantity inversely related to materiality
•
Thus as materiality
•
Risk is directly related to quantity
quantity
•
Economic Factors
•
Auditors work within economic limits
•
Auditor should not accept client-imposed time
and cost restrictions
•
Population Size and Characteristics
•
Sampling is a practical necessity
•
Generally the larger the population, the larger the
sample
•
There is an upper limit
•
Population characteristics
•
Uniform vs. non-uniform populations
Quality of Evidence
•
How appropriate is the evidence?
•
Considerations for quality
1. Relevance
• Evidence must be pertinent
•
If the audit objective is inventory quantity?
•
But how about ownership of a fixed asset?
2. Source
•
The circumstances in which the evidence is obtained
affects the quality of the evidence
•
Testing the Accounts Receivable balance
a. Examine evidence within the client’s organization
b. Ask the customer to communicate with you directly
•
Reviewing bank reconciliations
a. Prepared by internal audit
b. Prepared by the accounting manager
•
When evidence is obtained from independent
sources
•
A good system of internal control
•
Direct personal knowledge of the auditor
3. Timeliness
•
The date at which the evidence is obtained
•
E.g.. Physical count at the balance sheet date
4. Objectivity
•
Evidence from outside independent sources
•
Contrast this to management making estimates on
inventory obsolescence
Reasonable Basis
•
Auditor is not required to have absolute certainty
•
Reasonable basis pertains to the overall level of
assurance
•
Statistical quantification of assurance levels
•
Five factors that influence the auditor’s judgmental
decision concerning reasonable basis
1. Professional Considerations
•
CICA Handbook contains specific objectives to be
obtained during the course of the examination
•
Must justify departure
Competition among firms
(cost and fee conscious)
Inadequate basis for an opinion
(lawsuits?)
2. Integrity of Management
•
Remember the responsibilities of management
•
Doubt as to management integrity
3. Related Party Transactions
•
Between parent and its subsidiaries
•
Between a company and management
•
“Arm’s length” bargaining not possible
4. Public vs. Privately Held Companies
•
The general belief of auditors with regard to public
companies
5. Financial Condition
•
e.g. the threat of bankruptcy
•
Remember the section on legal liability
Types of Evidence
•
The third standard requires corroborating evidence
of the following types:
1.
2.
3.
4.
5.
6.
7.
8.
Physical evidence
Confirmations
Documentary evidence
Written representations
Mathematical evidence
Visual evidence
Oral evidence
Analytical evidence
1. Physical Evidence
•
Used widely for tangible assets
•
Direct personal knowledge
2. Confirmations
•
Direct written response by knowledgeable third parties
to specific requests
•
Useful in verifying existence and accuracy
3. Documentary Evidence
•
Cheques, invoices, contracts, minutes
•
How reliable is the document?
•
•
Externally generated third party
•
Internally created
Documents are used extensively to establish
•
Terms
•
Occurrence
•
Propriety of exchange transactions
•
Ownership of assets
•
Claims of creditors
•
Accuracy and completeness of accounting records
•
Internal control
4. Written Representations
•
A signed statement by a responsible and
knowledgeable individual
•
Management representation letter
•
Also written representations from outside experts
5. Mathematical Evidence
•
Auditors computations
•
E.g. checking journal footings
6. Visual Evidence
•
Auditor witnesses the performance of an assigned
responsibility or observes the security of inventory
7. Oral Evidence
•
Oral inquiries
•
Corroborating evidence
8. Analytical Evidence
•
Ratios and comparisons
Substantive Tests
•
Evidential matter required by the third examination
standard is obtained through two general classes of
auditing procedures
1. Test of details of transactions and balances
2. Analytical procedures
Tests of Transactions and Balances
1.
Tracing a sales invoice to the accounting records
2.
Counting cash on hand
•
What are both tests doing?
Analytical Procedures
•
Designed to verify the reasonableness of relationships
among various data to identify unusual fluctuations in
such data
•
E.g. the magnitude of the percentage increase/decrease
of accounts receivable from the prior year to the current
year
•
What other measures can be used?
Auditing Procedures for Tests of T/A’s and Balances
•
What does GAAS require?
•
Most widely used:
•
•
•
•
•
•
•
•
•
Inspect
Observe
Confirm
Inquire
Trace
Vouch
Recalculate
Count
Scan
1. Inspection
•
Careful scrutiny or detailed examination
•
Document inspection provides for evaluating
documentary evidence
•
Inspection of a tangible asset provides a means for
evaluation of ?
2. Observation
•
Watch and witness the performance of an activity
•
Direct personal knowledge
3. Confirmation
•
Formal inquiry that enables the auditor to obtain
information directly from an independent source
4. Inquiry
•
Oral or written inquiry by the auditor
5. Tracing
•
The auditor begins with the document(s) created when
the transaction is first executed and proceeds to follow
the evidence through the recording process
•
Effectives of this procedure is enhanced by?
6. Vouching
•
The auditor works from the accounting records back to
the documentation that served as a basis for entry
•
The opposite of tracing
7. Recalculation
•
Reperformance of calculations
8. Counting
•
Physical count of tangible resources
•
Any other type of counting?
9. Scanning
•
The rapid review of documents, records, and schedules
Evaluation of Evidential Matter
•
The auditor should be objective, careful, and
thorough
•
Limit the use of evidence to the specific assertion
•
No single piece of evidence is absolutely conclusive
Nature and Purpose of Working
Papers
•
Working papers provide :
•
The principal support for?
•
Evidence that the examination was in accordance
with?
•
A means for co-ordination and supervision
Types of Working Papers
•
Usually classified into the following groups:
1.
Audit plans and audit programs.
2.
Working trial balance.
3.
Schedules and analyses.
4.
Audit memoranda.
5.
Adjusting and reclassifying entries.
The General Standard
•
Working papers provide evidence of the auditor’s
technical training and proficiency
•
Show ability to apply auditing procedures applicable
in the circumstances
•
The content of the working papers reveals the scope of
the work
The Examination Standards
•
Used for co-ordination and control
•
The auditor’s study and evaluation of internal control
should be clearly documented
•
Working papers provide a means for documentation of
evidence on which to base an opinion
The Reporting Standards
•
Facilitate the preparation of the auditor’s report
•
Working papers should be traceable to the financial
statements
•
Evidence to show financial statements conform to
GAAP
ABC INC
Balance Sheet
A1
CASH
F/S1
200Y
200X
725
575
W/P
Ref.
Acc.
No.
A
Acc.
Title
Final
12/31/200X
Ledger
12/31/200Y
Cash
392
525
Final
12/31/200X
W/P
Ref.
Acc.
No.
Acc. Title
A2
100
Petty Cash
125
125
A3
101
Bank
450
400
575
525
Ledger
12/31/200Y
Adj.
Entries
ABC INC
Adjusting Entries
c 125
^
c = counted
A1
(1)
Cash
A1 725
Final
12/31/200Y
(1) 250
A2
125
A3
650
725 F/S
^
Bank balance
25
100
Final
12/31/200Y
(1) 250
ABC INC
#101 Bank
ABC INC
A2
#100 Petty Cash
Currency
Adj.
Entries
A1
ABC INC
Cash Lead Sheet
Coins
TB1
ABC INC
Working Trial Balance
AE1
Note
A3
400
AE1 250
650
^
A1
250 A3
N/R
Note collected by bank
250
= per bank confirmation
^
= adds
Problem 1: The following are examples of audit procedures:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
Review the accounts receivable with the credit manager to evaluate their collectibility.
Stand by the payroll time cock to determine whether any employee ‘punches in” more then
one time.
Count inventory items and record the amount in the audit working papers.
Obtain a letter from the client’s law firm addressed to the public accounting firm stating that
the law firm is not aware of existing law suits.
Extend the cost of inventory times the quantity on an inventory listing to test whether it is
accurate.
Obtain a letter from an insurance company to the public accountant firm stating the amount
of the fire insurance coverage on building and equipment.
Examine an insurance policy stating the amount of the fire insurance coverage on buildings
and equipment.
Calculate the ratio of cost of goods sold to sales as a test of overall reasonableness of gross
margin relative to the preceding year.
Obtain information about the system of internal controls by asking the client to fill out a
questionnaire.
Trace the total of the cash disbursements journal to the general ledger.
Watch employees count inventory to determine whether company procedures are being
followed.
Examine a piece of equipment to make sure a major acquisition was actually received and is
in operation.
Calculate the ratio of sales commissions expense to sales as a test of sales commissions.
Examine corporate minutes of directors’ meetings to determine the authorization
of the issue of bonds.
15.
Obtain a letter from management stating there are no unrecorded liabilities.
16.
Review the total repairs and maintenance for each month to determine whether any
month’s total was unusually large.
17.
Compare a duplicate sales invoice with the sales journal for customer name and
amount.
18.
Add the sales journal entries to determine whether they were correctly totaled.
19.
Make a petty cash count to make sure the amount of the petty cash fund is intact.
20.
Obtain a written statement from a bank stating the client has $15,671 on deposit
and liabilities of $50,000 on a demand note.
Required:
Classify each of the preceding items according to the seven types of audit evidence:
(1) Physical examination, (2) Confirmation, (3) Documentation, (4) Observation,
(5) Inquiries of the client, (6) Reperformance, and (7) Analytical procedures.
14.
Problem 2: The following audit procedures were performed in the audit of inventory to satisfy
specific balance-related audit objectives as discussed in Chapter 5. The audit procedures
assume the auditor has obtained the inventory count records that list the client’s inventory.
The general balance-related audit objectives from Chapter 5 are also included.
AUDIT PROCEDURES
1.
Using audit software, extend unit prices time quantity, foot the extensions, and compare the
total to the general ledger.
2.
Trace selected quantities from the inventory listing to the physical inventory to make sure
the items exist and the quantities are the same.
3.
Question operating personnel about the possibility of obsolete or slow-moving inventory.
4.
Select a sample of quantities of inventory in the factory warehouse, and trace each item to
the inventory count sheets to determine if it has been included and if the quantity and
description are correct.
5.
Using both this year’s and last year’s inventory data files, compare quantities on hand and
unit prices, printing any with greater than a thirty percent or $15,000 variation from one year
to the next.
6.
Examine sales invoice and contracts with customers to determine if any goods are out on
consignment with customers. Similarly, examine vendors’ invoices and contracts with
vendors to determine if any goods on the inventory listing are owned by others.
7.
Send letters directly to third parties who hold the client’s inventory and request that they
respond directly to us.
GENERAL BALANCE-RELATED AUDIT OBJECTIVES
Existence
Completeness
Valuation
Accuracy
Classification
Cutoff
Detail tie-in
Rights and obligations
Presentation and disclosure
Required
a.
Identify the type of audit evidence used for each audit procedure.
b.
Identify the general balance-related audit objective or objectives satisfied by each
audit procedure.
Problem 3: The following are nine situations, each containing two means of accumulating evidence.
1.
2.
3.
4.
5.
6.
7.
8.
Confirm accounts receivable with business organizations versus confirming receivable with
consumers.
Physically examine 8-cm steel plates versus examining electronic parts.
Examine duplicate sales invoices when several competent people are checking one another’s
work versus examining documents prepared by a competent person in a one-person staff.
Physically examine inventory of parts for the number of units on hand versus examining
them for the likelihood of inventory being obsolete.
Confirm a bank balance versus confirming the oil and gas reserves with a geologist
specializing in oil and gas.
Confirm a bank balance versus examining the client’s bank statements.
Physically count the client’s inventory held by an independent party versus confirming the
count with an independent party.
Physically count the client’s inventory versus obtaining a count from the company president.
Required
a.
Fore each of the eight situations, state whether the first or second type of evidence is more
reliable.
b.
For each situation, state which of the factors discussed in the chapter affect the
appropriateness of the evidence.
Problem 4: In the audit of Worldwide Wholesale Inc., you performed extensive ratio and
trend analysis. No material exceptions were discovered except for the following:
1.
Commission expense as a percentage of sales had stayed constant for several years
but has increased significantly in the current year.
2.
The rate of inventory turnover has steadily decreased for four years.
3.
Inventory as a percentage of current assets had steadily increased for four years.
4.
The number of days’ sales in accounts receivable has steadily increased for three
years.
5.
Allowance for uncollectible accounts as a percentage of accounts receivable has
steadily decreased for three years.
6.
The absolute amounts of amortization expense and amortization expense as a
percentage of gross fixed assets are significantly smaller than in the preceding
year.
Required
a.
Evaluate the potential significance of each of the exceptions above for the fair
presentation of financial statements.
b.
State the following-up procedures you would use to determine the possibility of
material misstatements.