SPECIFIC TYPES OF AUDIT EVIDENCE

References ISA 505 – External confirmations “SAICA Handbook” or IFAC website ISA 540 – Auditing accounting estimates ISA 520 – Analytical procedures “ It is imperative for topics relating to ISA 540 & ISA 520 that the standards themselves are used for study purposes.

Learning Outcomes Explain the auditor’s responsibility relating to: external confirmations (ISA 505) the audit of accounting estimates(ISA 540) the performance of analytical procedures (ISA 520) in regard to account balances at the end of the financial year being audited. Describe the audit procedures that the auditor should carry out to discharge his/her responsibility regarding: the use of external confirmations(ISA505) the estimates included in account balances(ISA540) analytical procedures (ISA520) Explain the reliability of external confirmations in a given scenario in terms of the appropriateness of audit evidence(ISA505)

External Confirmations – ISA 505

External Confirmations 1. Introduction – ISA505 para 2 Use of External Confirmations Bank information Accounts receivable (e.g. trade debtor balances) Investments Inventory held by third parties Loan amounts/outstanding debt Documents held in safe custody Legal matters Title Deeds to obtain Audit evidence and reliability: Source: external / internal; level of authority. Obtained direct or indirect/by inference. Form: documentary (paper/electronic) / verbal. For which assertions can audit evidence be obtained through external confirmations? (i.t.o. account balances) Existence, Rights / Obligations, Valuation and/or Completeness?

2. Requirements – ISA505 para 7 2.1 When performing external confirmation; procedures: - Control over process - What Information? - Confirming party? Design request Send NB: obtain management permission to send beforehand

2. Requirements – ISA505 para 8 2.2 If management refuses permission to confirm: Reason? Reasonable? Impact on risk assessment (RMM) /risk of fraud? Alternative procedures... Objective: must regardless, obtain sufficient appropriate audit evidence! What if can’t?

2. Requirements – ISA505 para 9 2.3 Doubts as to reliability of audit evidence from external confirmation Impact on risk assessment (RMM)/risk of fraud? Alternative procedures Evidence , then impact on audit opinion

2. Requirements – ISA505 para 06 2.4 Types of External Confirmation Requests Positive confirmation request Respond if agree or disagree Negative confirmation request Respond only if disagree Which offers more reliable audit evidence?

Examples Example of a bank confirmation (SAAPS 1100) Examples of alternative audit procedures If cannot confirm a debtor’s balance? If cannot confirm a creditor’s balance?

Auditing Accounting Estimates – ISA 540

Auditor’s Responsibility/Objective Introduction – ISA 540 para 6 Definition “An approximation of a monetary amount in the absence of a precise means of measurement.” Examples Auditor’s Responsibility/Objective Allowance for doubtful debts, allowance for inventory obsolescence,warranty obligations, depreciation or asset useful life, outcome of long term contracts, cost arisng from litigation or judgements,provisions against the carying amount of the investment if recoverability uncertain Sufficient appropriate audit evidence about: (a) accounting estimates reasonable; (b) related disclosures in the financial statements are adequate.

Definitions – ISA 540 para 7 Other Definitions “Auditor’s point estimate – The amount, or range of amounts, respectively, derived from audit evidence for use in evaluating management’s point estimate.” - ISA540 para7(b) “Estimation uncertainty – The susceptibility of an accounting estimate and related disclosures to an inherent lack of precision in its measurement.” - ISA540 para 7(c) “Management bias - A lack of neutrality by management in the preparation of information” - ISA540 para 7(d) “Management’s point estimate – The amount selected by management for recognition or disclosure in the financial statements as an accounting estimate.” - ISA540 para 7(e) “Outcome of an accounting estimate – The actual monetary amount which results from the resolution of the underlying transaction(s), event(s) or condition(s) addressed by the accounting estimate.” - ISA540 para 7(f)

Nature of Accounting Estimates – ISA 540 para 2 Risk of material misstatement in accounting estimates varies: dependent on the level of estimation uncertainty of the estimate involved, in turn dependent on:   Complexity of the business activities of the entity; Frequency at which the estimate is made (routine/non-routine transactions); Availability (“Observability”) of data; Ease at which the method of measurement is applied, as prescribed by IFRS; “Model” used to measure the estimate.

Requirements – ISA 540 para 8-11 1. Risk Assessment Procedures: ID and Assess RMM Auditor’s considerations when determining the risks associated with estimates:   The requirements of the financial reporting framework (e.g. IFRS)? How management identifies indicators that give rise to the need for estimates? How does management make the estimate? On what data is it based? The method used Relevant controls Whether an expert was used Underlying assumptions Changes in the method used from the prior period How management has assessed the effect of estimation uncertainty  What is the estimation uncertainty associated with the estimate? Is there a significant risk associated with the estimate?

Requirements – ISA 540 para 12-14 2. Responses to the Assessed Risk of Material Misstatements Put risk assessment into action (i.e. respond to the information obtained as per the previous slide): Auditor determines whether: Requirements of the applicable financial reporting framework have been applied appropriately? Expert is needed in assisting with valuation? Controls were in place when management made estimate? Auditor tests whether: Methods used by management are appropriate and have been applied consistently; Assumptions used are reasonable; Management’s point estimate reasonable compared to auditor’s.

Requirements – ISA 540 para 21-22 Indicators of Possible Management Bias Review the judgments/decisions made by management to identify whether there are indicators of possible management bias. Written Representations Obtain written representations from management whether they believe significant assumptions are reasonable.

Analytical Procedures ISA 520 RO/RGO302

There are two ways to accumulate audit evidence. APPLICABILITY There are two ways to accumulate audit evidence. Test the controls and/or Perform substantive tests on the transactions and the balances Test of detail Analytical procedures ISA -520

When would we as auditors make use of ISA 520 ? APPLICABILITY ISA 520 para 1 and 3. When would we as auditors make use of ISA 520 ? 1. As a substantive procedure During an audit For relevant , reliable evidence, as to an assertion/s Alone/in combination with other substantive tests of detail. To corroborate conclusions formed at the end of the audit Suggestion of responsibility to perform in the final conclusion of the audit 3. Risk assessment ( but this is covered by ISA315)

What is an analytical procedure? ANALYTICAL REVIEW DEFINED ISA 520 para 4. What is an analytical procedure? Comparison / Relationship Evaluation

Comparison/Relationship ANALYTICAL REVIEW DEFINED ISA 520 para 4. and A1. to A3. Comparison/Relationship of to other Financial ,non financial and operating data of Current financial transactions/ balances individually aggregated dissembled Prior periods Budgets Same/similar industry Auditors expectations etc.

Comparison/Relationship ANALYTICAL REVIEW DEFINED ISA 520 para 4. and A1. to A3 Comparison/Relationship This can take the form of : Ratios Percentages Volumes Averages GP% Payroll costs to number of employees etc.

Evaluation ANALYTICAL REVIEW DEFINED The auditor would need to: ISA 520 para 4. and 5 and A15. to A21. Evaluation The results must be evaluated against predetermined expectations The auditor would need to: Get explanations from management as to why any results differ from the expected Corroborate these explanations Perform further substantive tests of detail if still not satisfied

DESIGNING & PERFORMING PROCEDURES ISA 520 para. 5 and A12 to A16 In designing Analytical Procedures the auditor should consider: Suitability of actual analytical procedure Reliability of data Predetermined expectations Need to determine an amount of acceptable difference based on materiality and desired level of assurance

material misstatement DESIGNING & PERFORMING PROCEDURES ISA 520 para. 5 and A6. to A10. 1.Suitability? Degree of reliance Of procedure for purpose Assessed risk of material misstatement Predictable

DESIGNING & PERFORMING PROCEDURES ISA 520 para. 5 and A12 2.Reliability? Preparation Independent Source Nature & relevance eg Not relevant if comparing to budget and budget goal driven as opposed to realistic Comparing motor industry to banking Comparability Nature and relevance

DESIGNING & PERFORMING PROCEDURES ISA 520 para. 5 and A15 3.Predetermined expectation! Detection of material misstatement Precision of results ? Nature & relevance eg Not relevant if comparing to budget and budget goal driven as opposed to realistic Comparing motor industry to banking Dissembling of information

EXAMPLE A typical , basic analytical procedure that one may perform for a dairy’s sales (Financial year end 31 December) First : Dissemble the information e.g. Ice cream sales Milk sales Cream sales etc. Second: Determine expectations e.g. Sales increased 8% on previous year, increase occurring on 1January 2013 (management’s documented price increase policy) Higher sales in summer and the holiday seasons Lower sales in winter

EXAMPLES

EXAMPLE A typical , basic analytical procedure that one may perform for a dairy’s sales Third: Accumulate data Fourth: Analyse data e.g. ask management why April and May are lower than last year ? June through to July are lower than last year ? Fifth: Corroborate management’s reasons Perform additional tests if necessary

DESIGNING & PERFORMING PROCEDURES SUMMARY Corroborate expectations if necessary Predetermined Expectation! Gather & dissemble data Ensure data agrees to the financial records Compare data to expectations Determine reasons for any differences Nature & relevance eg Not relevant if comparing to budget and budget goal driven as opposed to realistic Comparing motor industry to banking Corroborate reasons

END THANK YOU! BAIE DANKIE! ENKOSI KAKHULU!