1. CANADIAN EDITION AUDITING A PRACTICAL APPROACH Prepared by: Angela Davis CA, CFE, MSc Booth University College Copyright John Wiley & Sons Canada, Ltd. 1

2. CHAPTER 5 LEARNING OBJECTIVES Audit Evidence Copyright John Wiley & Sons Canada, Ltd. 2 1.Outline the audit assertions 2.Identify and describe different types of audit evidence and define sufficient appropriate audit evidence 3.Determine the persuasiveness of audit evidence 4.Explain the issues to consider when using the work of an expert 5.Explain the issues to consider when using the work of another auditor 6.Describe the evidence-gathering procedures most often used by auditors 7.Explain how auditors arrive at a conclusion based upon the evidence gathered 8.Describe how auditors document the details of evidence gathered in working papers

3. Audit Assertions Those charged with governance of an entity are responsible for ensuring that the financial statements provide a fair presentation of the entity and its operations Management make assertions about each account and related note disclosures –Assertions are statements regarding the recognition, measurement, presentation and disclosure of items included in the financial statements Copyright John Wiley & Sons Canada, Ltd. 3

4. Audit Assertions cont’d Auditors to use assertions for transactions, account balances and presentation and disclosures when assessing the risk of material misstatement and designing audit procedures Transaction based assertions focus on the transactions that took place during the period as opposed to the account balance. Copyright John Wiley & Sons Canada, Ltd. 4

5. Audit Assertions cont’d Assertions About Classes of Transactions Copyright John Wiley & Sons Canada, Ltd. 5 OccurrenceTransactions and events that have been recorded have occurred and pertain to the entity. CompletenessAll transactions and events that should have been recorded have been recorded. AccuracyAmounts and other data relating to recorded transactions and events have been recorded appropriately. Cut-offTransactions and events have been recorded in the correct accounting period. ClassificationTransactions and events have been recorded in the proper accounts Table 5.1

6. Audit Assertions cont’d Copyright John Wiley & Sons Canada, Ltd. 6 Transaction assertions –Occurrence Auditor gathers evidence that the transaction recorded by the client actually took place and relates to the entity –Most important where there is risk of overstatement (e.g. revenue) –Completeness Auditor gathers evidence that all transactions have been recorded by the client –Most important where there is risk of understatement (e.g. expenses)

7. Audit Assertions cont’d –Accuracy Auditor gathers evidence that transactions are recorded by the client at the appropriate amount –Most important where there is higher risk of inaccuracy (e.g. complex foreign exchange transactions) –Cut-off Auditor gathers evidence that the transactions have been recorded by the client in the correct period –Most important for transactions near year-end –Classification Auditor gathers evidence that transaction is in correct account Copyright John Wiley & Sons Canada, Ltd. 7

8. Assertions About Account Balances at Year End Copyright John Wiley & Sons Canada, Ltd. 8 Audit Assertions cont’d ExistenceAssets, liabilities and equity interests exist. Rights and obligations The entity holds or controls the rights to assets, and liabilities are the obligations of the entity. CompletenessAll assets, liabilities and equity interests that should have been recorded have been recorded. Valuation and allocation Assets, liabilities and equity interests are included in the financial report at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded. Table 5.2

9. Account balance assertions –Existence Auditor gathers evidence to recorded asset, liability, and equity items actually exist –Most important where there is risk of overstatement (e.g. assets) –Rights and Obligations Auditor gathers evidence that recorded assets are owned by entity and that recorded liabilities represent commitments of the entity –Most important where there is risk that items are held but not owned (e.g. inventory on consignment) Copyright John Wiley & Sons Canada, Ltd. 9 Audit Assertions cont’d

10. Copyright John Wiley & Sons Canada, Ltd. 10 –Completeness Auditor gathers evidence that asset, liability, and equity items have been recorded by the client –Most important where there is risk of understatement (e.g. unrecorded loans) –Valuation and allocation Auditor gathers evidence that asset, liability, and equity items have been recorded at appropriate amounts and allocated to the correct accounts by the client –Most important where there is risk of over or under statement (e.g. inventory at lower of cost and NRV, adequacy of doubtful debts or other provisions)

11. Audit Assertions cont’d Assertions About Presentation and Disclosure Copyright John Wiley & Sons Canada, Ltd. 11 Occurrence, rights and obligations Disclosed events, transactions and other matters have occurred and pertain to the entity. CompletenessAll disclosures that should have been included in the financial report have been included. Classification and understandability Financial information is appropriately presented and described, and disclosures are clearly expressed. Accuracy and valuation Financial and other information are disclosed fairly and at appropriate amounts. Table 5.3

12. Audit Assertions cont’d Presentation and disclosure assertions relate to all items included in the financial statements to ensure they are presented and disclosed appropriately The auditor searches to ensure that all items that should have been disclosed are included The auditor also checks that disclosed items represent events and transactions that have occurred, that they are recorded at the appropriate amount and described accurately. Copyright John Wiley & Sons Canada, Ltd. 12

13. Audit Evidence Evidence is the information that an auditor uses when arriving at their opinion on the fair presentation of their client’s financial statements (CAS 500) Auditor must gather sufficient appropriate evidence –Sufficiency relates to quantity of evidence –Appropriateness relates to quality of evidence –Audit risk determines what evidence is required Copyright John Wiley & Sons Canada, Ltd. 13

14. Audit Evidence cont’d Copyright John Wiley & Sons Canada, Ltd. 14 High-risk account Low-risk account Audit riskInherent riskControl riskDetection riskEvidence High LowMore Audit riskInherent riskControl riskDetection riskEvidence Low HighLess Table 5.4 Table 5.5

15. Audit Evidence cont’d Sufficiency of evidence gathered is a matter of professional judgement and will vary from account to account and client to client Appropriateness of evidence refers to relevance and reliability Evidence relevant if it provides confirmation about an assertion most at risk of material misstatement Copyright John Wiley & Sons Canada, Ltd. 15

16. Audit Evidence cont’d Reliability of evidence refers to information that reflects the true state of information In evaluating reliability of information the audit should consider: –Source of information specifically, independence of external third parties –Expertise of respondent –Consistency of information –Source of information internal specifically, is it produced in an environment where the internal controls operate effectively Copyright John Wiley & Sons Canada, Ltd. 16

17. Types of Audit Evidence External confirmations (CAS 505) –Auditor requests third party to confirm matter in confirmation letter. Including: –Banks: confirm cash balances, securities, loans –Creditors: confirm amount owed, terms, by client –Debtors: confirm amount owed to client –Others: confirm description and quantity of assets held –Negative form: reply if information incorrect –Hard to interpret non-response –Positive form: reply in all circumstances –Cannot know how well other party checked their records Copyright John Wiley & Sons Canada, Ltd. 17

18. Negative Confirmations Copyright John Wiley & Sons Canada, Ltd. 18

19. Types of Audit Evidence cont’d Documentary evidence, includes: Invoices, suppliers’ statements, bank statements, minutes of meetings, correspondence, legal agreements Can be internally or externally generated –Auditor can Verify information in client’s records to supporting external documents to confirm existence, rights and obligations (“vouching”), or Trace from documents to clients records to confirm classification, accuracy, completeness (“tracing”) Copyright John Wiley & Sons Canada, Ltd. 19

20. Types of Audit Evidence cont’d Auditor can request party to provide written representation Legal letter is sent by client to its lawyers to complete and return direct to auditor –Can include opinions on legal matters, details of disagreements with client etc (CAS 502) –Example figure 5.6 Management representation letter contains acknowledgement of management’s responsibilities, undertaking about legal compliance, confirmation of discussions (CAS 580) –Auditor still needs to gather other evidence –Example figure 5.7 Copyright John Wiley & Sons Canada, Ltd. 20

21. Management Representation Letter Copyright John Wiley & Sons Canada, Ltd. 21

22. Types of Audit Evidence cont’d Verbal evidence Auditor documents discussions with client management and staff Used to gain understanding of internal controls; corroborate other evidence Computational evidence Auditor checks mathematical accuracy; re-adding, can include complex re-calculations, verifying formulae Physical evidence Gathered by inspecting assets, to assess condition, to reconcile to client’s records Copyright John Wiley & Sons Canada, Ltd. 22

23. Types of Audit Evidence cont’d Electronic evidence Includes data held on client’s computer, emails to auditor, and scans and faxes No paper trail Auditor needs to consider the internal controls in place, including the quality of client’s computer system when assessing reliability of this evidence Copyright John Wiley & Sons Canada, Ltd. 23

24. Persuasiveness of Audit Evidence Auditor is seeking evidence to corroborate client’s recorded transactions and balances Greater corroboration is provided by more persuasive evidence Evidence types vary in persuasiveness Least to most persuasive: Evidence generated internally by client Evidence generated externally, held by client Externally generated evidence send direct to auditor Copyright John Wiley & Sons Canada, Ltd. 24

25. Persuasiveness of Audit Evidence cont’d Internally generated evidence: Includes records of cheques sent, copies of invoices and statements sent to customers, purchase orders, company documentation regarding policies and procedures, contracts, minutes of meetings, journals, ledgers, trial balances, spreadsheets, worksheets, reconciliations, calculations and computations Could be held in paper or electronic form Least persuasive because it is possible that client could manipulate or omit this type of evidence Copyright John Wiley & Sons Canada, Ltd. 25

26. Externally generated, held by client: Includes supplier invoices and statements, customer orders, bank statements, contracts, lease agreements, tax assessments Originals are more persuasive than photocopies More persuasive than internally generated evidence because it is produced by third parties Still possible that client could omit or tamper with evidence Copyright John Wiley & Sons Canada, Ltd. 26 Persuasiveness of Audit Evidence cont’d

27. Externally generated, sent direct to auditor: Includes bank confirmations, accounts receivable confirmations, correspondence with client’s lawyers, experts valuations Most reliable type of evidence because it is independent of client Client has no opportunity to alter evidence More reliable when external party is considered to be more reliable, trustworthy, independent of client Copyright John Wiley & Sons Canada, Ltd. 27 Persuasiveness of Audit Evidence cont’d

28. Auditor may engage expert to help in audit when auditor does not possess required skills and knowledge to assess item –Expert could be member of audit team, audit firm, client, or independent –CAS 620 provides guidance Is expert required? Determining scope of work for expert Selecting expert – assessing objectivity, capability of expert Assessing work of expert Auditor is responsible for drawing conclusions Copyright John Wiley & Sons Canada, Ltd. 28 Using Work of an Expert

29. Using Work of an Expert cont’d –Assessing need to use an expert. Consider: –Knowledge of audit team –Significance and complexity of item being assessed –Availability of appropriate alternative corroborating evidence The less knowledge held by audit team, the greater risk of material misstatement and less corroborating evidence available, the more likely an expert required –Scope of work to be carried out Auditor must set nature, timing and extent of work Use written instructions covering issues expert will report on, and how work will be used by auditor Copyright John Wiley & Sons Canada, Ltd. 29

30. Using Work of an Expert cont’d –Assessing capability of expert Consider expert’s qualifications, membership of professional body, reputation in the field, experience –Assessing objectivity of expert More objective if not connected to client –Assessing the expert’s report Report should be understandable to non-expert Include process, assumptions, data used by expert Auditor considers consistency with other information –Responsibility for the conclusion Auditor responsible for quality of evidence of expert’s work Copyright John Wiley & Sons Canada, Ltd. 30

31. Using Work of Another Auditor Group engagement partner responsible for signing audit report, but may use other auditors, especially for remote locations –Consider capacity of component auditors to undertake the work (CAS 600) –Component auditor’s work must be to same standard as group engagement partner Objectivity Gathering sufficient, appropriate evidence Copyright John Wiley & Sons Canada, Ltd. 31

32. Evidence Gathering Procedures Evidence gathering occurs throughout audit Guidance about primary evidence gathering techniques contained in CAS 500 –Inspection of records and documents e.g. for evidence of authorization, to check amounts –Inspection of tangible assets e.g. that they exist, their condition, to trace to records –Observation of client staff e.g. that they conduct inventory count correctly Provides evidence only for date of observation Copyright John Wiley & Sons Canada, Ltd. 32

33. Evidence Gathering Procedures cont’d –Enquiry Useful to for gaining understanding, or to corroborate other evidence; auditor will document conversation –Recalculations To check mathematical accuracy –Re-performance Follow the process used by client –Analytical procedures Relationships between data Copyright John Wiley & Sons Canada, Ltd. 33

34. Drawing Conclusions Does the auditor have sufficient, appropriate evidence on which to base conclusions? –CAS 500 Does evidence address significant risks faced by the client? –CAS 315 Form an audit opinion and report –See chapter 12 Copyright John Wiley & Sons Canada, Ltd. 34

35. Working Papers Auditor must document each stage of the audit in working papers (CAS 230) –Provides evidence of work completed, details evidence gathered to support opinion –Include in a working paper Client name, audit period Title of contents of paper, file reference Details of preparer, reviewer Cross references to other documents Copyright John Wiley & Sons Canada, Ltd. 35

36. Working Papers cont’d –Permanent file Client information and documentation that apply to more than one audit –e.g. client address, key personnel, long term contracts –Main accounting policies, results of prior audits –Copies of prior period financial statements –Current file Client information and documentation that apply to current audit –Evidence gathered for this audit Copyright John Wiley & Sons Canada, Ltd. 36

37. Working Papers cont’d Copyright John Wiley & Sons Canada, Ltd. 37 Figure 5.4

38. Copyright John Wiley & Sons Canada, Ltd. 38 Figure 5.6 Working Papers cont’d

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