Audit Evidence and Documentation

1. Audit Evidence and Documentation • C Delano Gray • September 26, 2006

2. Legal Liability

3. Understand the litigious environment in which CPAs practice.

4. Changed Legal Environment Audit professionals have a responsibility under common law to fulfill implied or expressed contracts with clients. They are liable to their clients for negligence and/or breach of contract should they fail to provide the services or not exercise due care in their performance.

5. Explain why the failure of financial statement users to differentiate among business failure, audit failure, and audit risk has resulted in lawsuits.

6. Business Failure, AuditFailure, and Audit Risk Audit failure Business failure Audit risk

7. Business Failure, AuditFailure, and Audit Risk Business failure It occurs when a business is unable to repay its lenders or meet the expectations of its investors because of economic or business conditions.

8. Business Failure, AuditFailure, and Audit Risk Audit failure It occurs when the auditor issues an erroneous audit opinion as the result of an underlying failure to comply with the requirements of generally accepted auditing standards (GAAS).

9. Business Failure, AuditFailure, and Audit Risk Audit risk It represents the risk that the auditor will conclude that the financial statements are fairly stated and an unqualified opinion can be issued when, in fact, they are materially misstated.

10. Use the primary legal concepts and the terms concerning accountants’ liability as a basis for studying legal liability of auditors.

11. Legal ConceptsAffecting Liability Prudent person concept Liability for the acts of others Lack of privileged communication

12. Legal Terms AffectingCPAs’ Liability Terms related to negligence and fraud: Ordinary negligence Gross negligence Constructive fraud Fraud

13. Legal Terms AffectingCPAs’ Liability Terms related to contract law: Breach of contract Third party beneficiary

14. Legal Terms AffectingCPAs’ Liability Other terms: Common law Statutory law Joint and several liability Separate and proportionate liability

15. Major Sources ofAuditor’s Legal Liability Client Third party Federal securities laws Criminal liability

16. Describe accountants’ liability to clients and related defenses.

17. Liability to Clients The most common source of lawsuits against CPAs is from clients.

18. Auditor’s DefensesAgainst Client Suits Lack of duty to perform Nonnegligent performance Contributory negligence Absence of causal connection

19. Evidence • Support for Audit and Opinion

20. Audit Documentation Audit documentation is the principal record of auditing procedures applied, evidence obtained, and conclusions reached by the auditor in the engagement.

21. AU 326 • SAS 31 SAS 48 SAS 80. • Assertions: • Existence or Occurrence • Completeness • Rights and Obligation • Valuation or Allocation • Presentation and Disclosure

22. Contrast audit evidence with evidence used by other professions.

23. Nature of Evidence The use of evidence is not unique to auditors. Evidence is also used by scientists, lawyers, and historians.

24. Identify the four audit evidence decisions that are needed to create an audit program.

25. Audit Evidence Decisions 1. Which audit procedures to use 2. What sample size to select for a given procedure 3. Which items to select from the population 4. When to perform the procedures

26. Audit Program It includes a list of the audit procedures the auditor considers necessary. Most auditors use computers to facilitate the preparation of audit programs.

27. Specify the characteristics that determine the persuasiveness of evidence.

28. Persuasiveness of Evidence Competence Sufficiency Combined effect Persuasiveness and cost

29. Competence Relevance Independence of provider Effectiveness of internal controls Auditor’s direct knowledge Qualifications of provider Objectivity of evidence Timeliness

30. Identify and apply the seven types of evidence used in auditing.

31. Types of Audit Evidence 1. Physical evidence 2. Confirmation 3. Documentation 4. Analytical procedures 5. Inquiries of the client 6. Reperformance 7. Observation

32. Broad guidelines Qualifications and conduct Evidence accumulation Reporting Types of evidence Broad categories Relationships Auditing standards

33. Audit procedures Specific instructions Sample size Items to select Timing of tests Relationships Types of evidence

34. Information Source Assets Cash in bank Bank Accounts receivable Customer Notes receivable Maker Owned inventory out on consignment Consignee Inventory held in public warehouses Warehouse Cash surrender value of life insurance Insurance co. InformationOften Confirmed

35. InformationOften Confirmed Information Source Liabilities Accounts payable Creditor Notes payable Lender Advances from customers Customer Mortgages payable Mortgagor Bonds payable Bondholder

36. InformationOften Confirmed Information Source Owners’ Equity Shares outstanding Registrar and transfer agent

37. InformationOften Confirmed Information Source Other Information Insurance coverage Insurance company Contingent liabilities Bank, lender, and client’s counsel Bond indenture agreements Bondholder Collateral held by creditors Creditor

38. InformationOften Confirmed Documentation Analytical procedures Inquiries of the client Reperformance Observation

39. Competence of Typesof Evidence Type of evidence Independence of provider Effectiveness of client’s internal controls Auditor’s direct knowledge Qualifications of provider Objectivity of evidence

40. Terms Types of Evidence Examine Scan Read Compute Recompute Foot Documentation Analytical procedures Documentation Analytical procedures Reperformance Reperformance Terms and Types of Evidence

41. Terms and Types of Evidence Terms Types of Evidence Trace Compare Count Observe Inquire Vouch Documentation Documentation Physical examination Observation Inquiries of client Documentation

42. Understand the purposes of audit documentation.

43. Audit Documentation Purposes of audit documentation Ownership of audit files Confidentiality of audit files

44. Audit Documentation Audit documentation is the principal record of auditing procedures applied, evidence obtained, and conclusions reached by the auditor in the engagement.

45. Audit Documentation The Sarbanes-Oxley Act requires auditors of public companies to prepare and maintain audit working papers for a period of no less than seven years.

46. Prepare organized audit documentation.

47. Financial Statements and Audit Report Analytical Procedures Test of Controls & Substantive TOT Working Trial Balance Derrickson Associates Trial Balance 12/31/2004 Cash $165,237 Accounts Receivable 275,050 Prepaid Insurance 37,795 Interest Receivable 20,493 Adjusting Journal Entries Internal Control Contingent Liabilities General Information Operations Liabilities and Equity Audit Programs Assets Permanent Files Audit File Contentsand Organization

48. Permanent Files These files are intended to contain data of a historical or continuing nature pertinent to the current audit.

49. Current Files Audit program General information Working trial balance Adjusting and reclassification entries Supporting schedules

50. Relationship of Audit Documentationto Financial Statements FINANCIAL STATEMENTS Cash 122 Acc. …………………. WORKING TRIAL BALANCE Prelim.AJE’sFinal Cash 212 (90) 122 AJE’s Expense 90 Cash 90 LEAD SCHEDULE – CASHA-1 Per G/LAJE’sFinal Petty Cash A-2 5 5 Cash in Bank: General A-3 186 (90) 96 Payroll A-4 21 21 212 (90) 122