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ISA 500 requires that auditors obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion.

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Presentation on theme: "ISA 500 requires that auditors obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion."— Presentation transcript:

1 ISA 500 requires that auditors obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the audit opinion. Characteristics of audit evidence: 1.Sufficiency 2.Appropriateness

2 1. Sufficiency is the measure of the quantity of audit evidence. another auditor looking at the same body of evidence should arrive at the same conclusion. factors that influence the sufficiency of the evidence obtained – The auditor’s knowledge and experience of the business. Where the auditor has good past knowledge of the business and trusts the integrity of staff then less evidence will be required. – Assessment of risk at the financial statement level and/or the individual transaction level. As risk increases then more evidence is required. – The materiality of the item. More evidence will normally be collected on material items whereas immaterial items may simply be reviewed to ensure they appear correct. – The nature of the accounting and internal control systems. The auditor will place more reliance on good accounting and internal control systems limiting the amount of audit evidence required. – The source and reliability of the information. Where evidence is obtained from reliable sources (e.g. written evidence), then less evidence is required than if the source was unreliable (e.g. verbal evidence).

3 2. Appropriateness is the measure of the quality of the audit evidence. - Relevance is considered in relation to F/S assertions. - Reliability external>internal directly>indirectly Strong IC>Weak IC written>oral original> Photocopies or facsimiles

4 Audit procedures AEIOU

5 Audit procedures Term and definitionIllustrative procedures Assertions (substantive test) enquiry/ inquiry Inquire- obtain written or oral information from the client in response to questions from the auditor. Used extensively throughout the audit and is complementary to performing other procedures. Inquire mgt whether there is any obsolete inventory on hand at the B/S date. Ask mgt to provide a written representation that they are not aware of any legal claims against the company other than those disclosed in the F/Ss.

6 Audit procedures Term and definitionIllustrative procedures Assertions (substantive test) confirm ation Confirm- receive a written or oral response from an independent third party verifying the accuracy of information that was requested by the auditor. the request is made to the client, and the client asks the independent third party to respond directly to the auditor. Confirm from bank of cash in bank. Confirm from customer of accounts receivable. Confirm from vendor of accounts payable. Confirm from consignee of owned inventory out on consignment. Confirm from legal counsel of provisions or contingent liabilities Existence Cutoff Valuation (cash)

7 Audit procedures Term and definitionIllustrative procedures Assertions (substantive test) observation Observe- watch a control procedure being performed. Only confirms control procedure took place when auditor is watching. Observe whether the two inventory count teams independently count and record inventory units. Observe whether personnel signs his or her name when the wage packet is distributed. completeness existence

8 Audit procedures Term and definitionIllustrative procedures Assertions (substantive test) Inspection of tangible assets Inspect – determine assets on hand at a given time. Inspect cash, inventory, fixed assets that are recorded in the accounting records. Confirm Existence Not confirm Rights and obligations or Valuation Confirmation that assets seen are recorded in accounting records gives evidence of completeness

9 Audit procedures Term and definitionIllustrative procedures Assertions (substantive test) Inspection of document ations or records Check/review/examine – a reasonably detailed study of a document or record to determine specific facts about it. check a sample of sales order for evidence of proper credit approval by the appropriate senior staff member. Check title deeds and land registry certificates to verify title to land and buildings. Rights and obligations Read – an examination of written information to determine facts pertinent to the audit. Read the minutes of a board of directors meeting and summarize all information that is pertinent to the F/Ss in a working paper.

10 Audit procedures Term and definitionIllustrative procedures Assertions (substantive test) Inspectio n of documen tations or records Vouch – the use of documents to verify recorded transactions or amounts. Vouch/trace a sample of sales transactions from sales journal entries to copies of sales orders, sales invoices, and shipping documents. Existence Occurrence Trace- find information in different locations by cross reference. The instruction should state what the auditor is tracing and where it is tracing from and to. Often, an audit procedure that includes the term trace will also include a second instruction, such as compare or recalculate. Trace a sample of sales transactions from shipping documents to sales invoices and entries into sales journal. Trace postings from the sales journal to the general ledger accounts. completeness

11 Audit procedures Term and definitionIllustrative procedures Assertions (substantive test) Inspection of document ations or records Compare- a comparison of information in two different locations. The instruction should state which information is being compared in as much detail as possible. Select a sample of sales invoices and compare the unit selling price as stated on the invoice to the list of unit selling prices authorizes by mgt. Accuracy Valuation and allocation Compare dates of recorded sales transactions with dates on shipping records. Cut-off

12 Audit procedures Term and definitionIllustrative procedures Assertions (substantive test) reperform ance Reperform – the auditor’s independent execution of control procedures that were originally performed by the entity. Reperform inventory counting Reperform the preparation of schedule of accounts receivable by age. recalculati on Recompute – a calculation done to determine whether a client’s calculation is correct. Recompute the unit sales price times the number of units for a sample of sales invoices and compare the totals with the calculations. Accuracy Valuation and allocation Foot – addition of a column of numbers to determine whether the total is the same as the client’s. Foot the sales journal for a 1-month period and compare all totals with the general ledger.

13 Audit procedures Term and definitionIllustrative procedures Assertions (substantive test) Analytical procedures Scan- a less detailed examination of a document or record to determine whether there is sth unusual warranting further investigation. Scan the sales journal, looking for large and unusual transactions. Compute – a calculation done by the auditor independent of the client. Compute the inventory turn over ratios and compare with those of previous years as a test of inventory obsolescence.

14 Analytical procedures are evaluating and comparing financial and/or non- financial data for plausible relationships. Also include the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts.

15 Five types of comparison in analytical procedures: 1.Compare client data with similar prior- period data. 2.Compare client and industry data. 3.Compare client data with client- determined expected results. 4.Compare client data with auditor- determined expected results. 5.Compare client data with expected results, using non-financial data.

16 1.Compare client data with similar prior-period data. Ratio or comparisonPossible misstatement Raw material turnover for a manufacturing company Misstatement of inventory or cost of goods sold or obsolescence of raw material inventory Sales commissions divided by net sales Misstatement of sales commissions Sales returns and allowances divided by gross sales Unrecorded returns or allowances subsequent to year- end Each of the individual manufacturing expenses as a percentage of total manufacturing expense Significant misstatement of individual expenses within a total

17 2. Compare client and industry data. clientindustry 2009200820092008 Inventory turnover 3.43.53.93.4 Gross margin percent 26.3%26.4%27.3%26.2% The company may have lost market share Its pricing may not be competitive It may have incurred abnormal costs It may have obsolete items in inventory

18 3. Compare client data with client- determined expected results. Because budgets represent the client’s expectations for the period, an investigation of the most significant areas in which differences exist between budgeted and actual results may indicate potential problems.

19 4. Compare client data with auditor- determined expected results. eg. Independent calculation of interest expense on long-term notes payable by multiplying the ending monthly balance in notes payable by the average monthly interest rate.

20 5. Compare client data with expected results, using non-financial data. Total revenue from rooms in a hotel number of rooms × room rate for each room × occupancy rate Tuition revenue at a university Average tuition × enrollment Factory payrollTotal hours worked × wage rate Cost of inventory soldUnits sold × inventory cost per unit

21 Three methods of analytical procedures: 1.Trend analysis (including regression analysis): compare current data with those in prior periods 2.Ratio analysis (Financial ratio, non- financial ratio) 3.Reasonable test (proof in total) June 2008 Q3b

22 Key financial ratios Gross profit margin (in total and by product, area and month/quarter) =Gross profit / turnover X100% Current ratio= Current assets / current liabilities X100% Quick ration= Current-inventory / current liabilities X100% Inventory turnover=Cost of sales / inventory X100% Receivable period=Receivables / sales X365 Payables period=Payables / cost of sales X365 Gearing ratio=Debt capital / equity capital X100%

23 Reasonable test (proof in total) involves calculating the expected value of an item and comparing it with its actual value. expected depreciation charge =(cost + additions – disposals) X depreciation rate expected wages this year = wages last year X (1 + inflation rate) X number of employees this year / number of employees last year expected ticket sales revenue of a cinema = number of visitors X admission charge

24 Exam tip: Mention of analytical procedures will generally be worth of a couple of marks in any question on substantive test. However you will not get any marks just for saying “perform analytical procedures”. You should give details of the specific procedure.

25 June 2009 Q1c B-Star is a theme park based on a popular series of children’s books. Customers pay a fixed fee to enter the park, where they can participate in a variety of activities such as riding roller-coasters, playing on slides and purchasing themed souvenirs from gift shops. The park is open all year and has been in operation for the last seven years. It is located in a country which has very little rainfall – the park is open-air so poor weather such as rain results in a significant fall in the number of customers for that day (normally by 50%). During the last seven years there have been on average 30 days each year with rain.

26 B-Star is now very successful; customer numbers are increasing at approximately 15% each year. Customers purchase tickets to enter the theme park from ticket offices located outside the park. Tickets are only valid on the day of purchase. Adults and children are charged the same price for admission to the park. You are now commencing the planning of the annual audit of B-Star. The date is 3 June 2009 and B-Star’s year end is 30 June 2009.

27 (i) List the substantive analytical procedures that may be used to give assurance on the total income from ticket sales for one day in B-Star; (ii) List the substantive analytical procedures that may be used to give assurance on the total income from ticket sales in B-Star for the year. (8 marks)

28 (i) Substantive analytical procedures – completeness of income for one day – Obtain proof in total. Tickets sold times price should equal day’s income. – Compare daily sales to budgeted daily sales (for example weekends and bank holidays would expect more income). – Compare sales with previous days and account for changes such as variations for weather. – Compare sales to souvenirs sales (more people in park means more souvenir sales). – Compare ticket offices day-by-day and staff rotation to see if sales lower some day/some staff (attempt to identify fraud also).

29 (ii) Substantive analytical procedures – completeness of income for the year – Obtain the sales income from the previous year. Multiply this by 115% to provide a rough estimate of the income for this year. – Obtain information on the number of days with rain during the last year. Where this is more or less than 30, adjust the income estimate by 1/730 down for each day of rain above 30 or 1/730 up for each day of rain less than 30. – Compare actual income to budgeted income for the year. Ask the directors to explain any significant deviations. – Obtain industry information on the popularity of theme parks, and change in customer numbers. Compare these trends to the results obtained by B-Star. Where B-Star performed significantly better or worse than average, obtain explanations from the directors.

30 Risk assessment procedures Tests of controlSubstantive tests enquiry observationObservationobservation* inspectioninspection of documentations or records inspection* walk-through test*walk-through test analytical procedure reperformance confirmation recalculation * Observing segregation of duties and physical control over assets and records are not substantive tests. * Examining copies of documents for proper authorisation, initials of internal verification are not substantive tests. * http://www.enet.com.cn/article/2012/0705/A20120705132474.shtml

31 Risk assessment procedures (text P113) Why? Auditor is required to obtain an understanding of the entity and its environment in order to be able to assess the risks of material misstatement. What? How?

32 Assessed control risk high low Test of control effectiveineffective Reduced substantive test Extensive substantive test

33 Test of controlSubstantive test Purpose Determine effectiveness of design and operation of IC Determine fairness of significant financial report assertions Nature of test measurement Frequency of deviations from IC Monetary errors in transactions and balances Applicable audit procedures TimingPrimary interim work Primarily at or shortly after B/S date Audit risk component CRDR

34 1.1 Substantive testTest of control F/S issued date Auditing planningY/E Final auditInterim audit


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