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  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. UNDERLYING ACCOUNTING DATA Worksheets, Computations, Reconciliations SUFFICIENT APPROPRIATE AUDIT EVIDENCE + = CORROBORATING INFORMATION Confirmations, Computation, Analysis The Nature of 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 tests • Second examination standard • There should be a study and evaluation of those internal controls on which the auditor subsequently relies

  6. Four primary concerns • Was 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 inspection • Inquiry and observation

  8. 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

  9. Sufficiency of Evidence • Pertains to quantity • Auditor’s judgment may be affected by: • Materiality and Risk • Economic factors • Size and characteristics of the population

  10. Materiality and Risk • Quantity inversely related to materiality • Thus as materiality quantity • Risk is directly related to quantity

  11. Economic Factors • Auditors work within economic limits • Auditor 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 sample • There is an upper limit • Population characteristics • Uniform vs. non-uniform populations

  13. Quality of Evidence • How appropriate is the evidence? • Considerations for quality • Relevance • Evidence must be pertinent • If the audit objective is inventory quantity? • But how about ownership of a fixed asset?

  14. 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

  15. When evidence is obtained from independent sources • A good system of internal control • Direct personal knowledge of the auditor

  16. Timeliness • The date at which the evidence is obtained • E.g.. Physical count at the balance sheet date • Objectivity • Evidence from outside independent sources • Contrast 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 assurance • Statistical quantification of assurance levels

  18. Competition among firms (cost and fee conscious) Inadequate basis for an opinion (lawsuits?) • Five factors that influence the auditor’s judgmental decision concerning reasonable basis • Professional Considerations • CICA Handbook contains specific objectives to be obtained during the course of the examination • Must justify departure

  19. Integrity of Management • Remember the responsibilities of management • Doubt as to management integrity • Related Party Transactions • Between parent and its subsidiaries • Between 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 companies • Financial Condition • e.g. the threat of bankruptcy • Remember the section on legal liability

  21. Types of Evidence • The third standard requires corroborating evidence of the following types: • Physical evidence • Confirmations • Documentary evidence • Written representations • Mathematical evidence • Visual evidence • Oral evidence • Analytical evidence

  22. Physical Evidence • Used widely for tangible assets • Direct personal knowledge • Confirmations • Direct written response by knowledgeable third parties to specific requests • Useful in verifying existence and accuracy

  23. 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

  24. Written Representations • A signed statement by a responsible and knowledgeable individual • Management representation letter • Also written representations from outside experts

  25. Mathematical Evidence • Auditors computations • E.g. checking journal footings • Visual Evidence • Auditor witnesses the performance of an assigned responsibility or observes the security of inventory

  26. Oral Evidence • Oral inquiries • Corroborating evidence • Analytical Evidence • Ratios and comparisons

  27. Substantive Tests • Evidential matter required by the third examination standard is obtained through two general classes of auditing procedures • Test of details of transactions and balances • Analytical procedures

  28. Tests of Transactions and Balances • Tracing a sales invoice to the accounting records • Counting cash on hand • What are both tests doing?

  29. 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?

  30. 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

  31. Inspection • Careful scrutiny or detailed examination • Document inspection provides for evaluating documentary evidence • Inspection of a tangible asset provides a means for evaluation of ?

  32. Observation • Watch and witness the performance of an activity • Direct personal knowledge • Confirmation • Formal inquiry that enables the auditor to obtain information directly from an independent source

  33. Inquiry • Oral or written inquiry by the auditor • 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?

  34. Vouching • The auditor works from the accounting records back to the documentation that served as a basis for entry • The opposite of tracing • Recalculation • Reperformance of calculations

  35. Counting • Physical count of tangible resources • Any other type of counting? • Scanning • The rapid review of documents, records, and schedules

  36. 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

  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 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

  40. 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

  41. 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

  42. F/S1 A1 TB1 A1 A1 A2 A3 F/S ^ A3 A2 AE1 AE1 ^ c A3 ^ c = counted = per bank confirmation = adds ^

  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 PROCEDURES • Using 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 Existence Completeness Valuation Accuracy Classification Cutoff Detail tie-in Rights and obligations Presentation and disclosure Required • Identify 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. Required • Fore 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., 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. Required • Evaluate 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.