2 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
3 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
4 The Nature of EvidenceUNDERLYING ACCOUNTING DATAWorksheets, Computations,ReconciliationsCORROBORATING INFORMATIONConfirmations, Computation,Analysis+SUFFICIENT APPROPRIATEAUDIT EVIDENCE=The underlying accounting data is indispensable as it provides the basis for the client’s F/S
5 Evidence Matter for Tests of Controls Tests of controls or compliance testsSecond examination standardThere should be a study and evaluation of those internal controls on which the auditor subsequently relies
6 Four primary concernsWas the specific control procedure actually performed?Was it performed properly?By the appropriate person?Throughout the period of reliance?
7 Two categories for tests of controls: Document inspectionInquiry and observation
8 Remember the third examination standard: The auditor must obtain sufficient and appropriate audit evidence to support the audit opinionThe auditor employs substantive procedures to gather evidence relating to transactions and balances
9 Sufficiency of Evidence Pertains to quantityAuditor’s judgment may be affected by:Materiality and RiskEconomic factorsSize and characteristics of the population
10 Materiality and RiskQuantity inversely related to materialityThus as materiality quantityRisk is directly related to quantity
11 Economic FactorsAuditors work within economic limitsAuditor should not accept client-imposed time and cost restrictions
12 Population Size and Characteristics Sampling is a practical necessity Generally the larger the population, the larger the sampleThere is an upper limitPopulation characteristicsUniform vs. non-uniform populations
13 Quality of Evidence How appropriate is the evidence? Considerations for qualityRelevanceEvidence must be pertinentIf the audit objective is inventory quantity?But how about ownership of a fixed asset?
14 Testing the Accounts Receivable balance SourceThe circumstances in which the evidence is obtained affects the quality of the evidenceTesting the Accounts Receivable balancea. Examine evidence within the client’s organizationb. Ask the customer to communicate with you directlyReviewing bank reconciliationsa. Prepared by internal auditb. Prepared by the accounting manager
15 When evidence is obtained from independent sources A good system of internal controlDirect personal knowledge of the auditor
16 TimelinessThe date at which the evidence is obtainedE.g.. Physical count at the balance sheet dateObjectivityEvidence from outside independent sourcesContrast this to management making estimates on inventory obsolescence
17 Reasonable Basis Auditor is not required to have absolute certainty Reasonable basis pertains to the overall level of assuranceStatistical quantification of assurance levels
18 Five factors that influence the auditor’s judgmental decision concerning reasonable basis Professional ConsiderationsCICA Handbook contains specific objectives to be obtained during the course of the examinationMust justify departureCompetition among firms(cost and fee conscious)Inadequate basis for an opinion(lawsuits?)
19 Integrity of Management Remember the responsibilities of managementDoubt as to management integrityRelated Party TransactionsBetween parent and its subsidiariesBetween a company and management“Arm’s length” bargaining not possible
20 Public vs. Privately Held Companies The general belief of auditors with regard to public companiesFinancial Conditione.g. the threat of bankruptcyRemember the section on legal liability
21 Types of EvidenceThe third standard requires corroborating evidence of the following types:Physical evidenceConfirmationsDocumentary evidenceWritten representationsMathematical evidenceVisual evidenceOral evidenceAnalytical evidence
22 Physical EvidenceUsed widely for tangible assetsDirect personal knowledgeConfirmationsDirect written response by knowledgeable third parties to specific requestsUseful in verifying existence and accuracy
23 Documentary Evidence Cheques, invoices, contracts, minutes How reliable is the document?Externally generated third partyInternally createdDocuments are used extensively to establishTermsOccurrencePropriety of exchange transactionsOwnership of assetsClaims of creditorsAccuracy and completeness of accounting recordsInternal control
24 Written Representations A signed statement by a responsible and knowledgeable individualManagement representation letterAlso written representations from outside experts
25 Mathematical Evidence Auditors computationsE.g. checking journal footingsVisual EvidenceAuditor witnesses the performance of an assigned responsibility or observes the security of inventory
26 Oral EvidenceOral inquiriesCorroborating evidenceAnalytical EvidenceRatios and comparisons
27 Substantive TestsEvidential matter required by the third examination standard is obtained through two general classes of auditing proceduresTest of details of transactions and balancesAnalytical procedures
28 Tests of Transactions and Balances Tracing a sales invoice to the accounting recordsCounting cash on handWhat are both tests doing?
29 Analytical Procedures Designed to verify the reasonableness of relationships among various data to identify unusual fluctuations in such dataE.g. the magnitude of the percentage increase/decrease of accounts receivable from the prior year to the current yearWhat other measures can be used?
30 Auditing Procedures for Tests of T/A’s and Balances What does GAAS require?Most widely used:InspectObserveConfirmInquireTraceVouchRecalculateCountScan
31 Inspection Careful scrutiny or detailed examination Document inspection provides for evaluating documentary evidenceInspection of a tangible asset provides a means for evaluation of ?
32 Observation Confirmation Watch and witness the performance of an activityDirect personal knowledgeConfirmationFormal inquiry that enables the auditor to obtain information directly from an independent source
33 Inquiry Tracing Oral or written inquiry by the auditor The auditor begins with the document(s) created when the transaction is first executed and proceeds to follow the evidence through the recording processEffectives of this procedure is enhanced by?
34 Vouching Recalculation The auditor works from the accounting records back to the documentation that served as a basis for entryThe opposite of tracingRecalculationReperformance of calculations
35 Counting Scanning Physical count of tangible resources Any other type of counting?ScanningThe rapid review of documents, records, and schedules
36 Evaluation of Evidential Matter The auditor should be objective, careful, and thoroughLimit the use of evidence to the specific assertionNo single piece of evidence is absolutely conclusive
37 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
38 Types of Working Papers Usually classified into the following groups:Audit plans and audit programs.Working trial balance.Schedules and analyses.Audit memoranda.Adjusting and reclassifying entries.
39 The General StandardWorking papers provide evidence of the auditor’s technical training and proficiencyShow ability to apply auditing procedures applicable in the circumstancesThe content of the working papers reveals the scope of the work
40 The Examination Standards Used for co-ordination and controlThe auditor’s study and evaluation of internal control should be clearly documentedWorking papers provide a means for documentation of evidence on which to base an opinion
41 The Reporting Standards Facilitate the preparation of the auditor’s reportWorking papers should be traceable to the financial statementsEvidence to show financial statements conform to GAAP
43 Problem 1: The following are examples of audit procedures: 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.
44 Examine corporate minutes of directors’ meetings to determine the authorization of the issue of bonds.Obtain a letter from management stating there are no unrecorded liabilities.Review the total repairs and maintenance for each month to determine whether any month’s total was unusually large.Compare a duplicate sales invoice with the sales journal for customer name and amount.Add the sales journal entries to determine whether they were correctly totaled.Make a petty cash count to make sure the amount of the petty cash fund is intact.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.
45 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 PROCEDURESUsing audit software, extend unit prices time quantity, foot the extensions, and compare the total to the general ledger.Trace selected quantities from the inventory listing to the physical inventory to make sure the items exist and the quantities are the same.Question operating personnel about the possibility of obsolete or slow-moving inventory.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.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.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.Send letters directly to third parties who hold the client’s inventory and request that they respond directly to us.
46 GENERAL BALANCE-RELATED AUDIT OBJECTIVES ExistenceCompletenessValuationAccuracyClassificationCutoffDetail tie-inRights and obligationsPresentation and disclosureRequiredIdentify the type of audit evidence used for each audit procedure.Identify the general balance-related audit objective or objectives satisfied by each audit procedure.
47 Problem 3: The following are nine situations, each containing two means of accumulating evidence. 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.RequiredFore each of the eight situations, state whether the first or second type of evidence is more reliable.For each situation, state which of the factors discussed in the chapter affect the appropriateness of the evidence.
48 Problem 4: In the audit of Worldwide Wholesale Inc 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:Commission expense as a percentage of sales had stayed constant for several years but has increased significantly in the current year.The rate of inventory turnover has steadily decreased for four years.Inventory as a percentage of current assets had steadily increased for four years.The number of days’ sales in accounts receivable has steadily increased for three years.Allowance for uncollectible accounts as a percentage of accounts receivable has steadily decreased for three years.The absolute amounts of amortization expense and amortization expense as a percentage of gross fixed assets are significantly smaller than in the preceding year.RequiredEvaluate the potential significance of each of the exceptions above for the fair presentation of financial statements.State the following-up procedures you would use to determine the possibility of material misstatements.