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Chapter 7

Chapter 7. Direct Tests of Account Balances. Overview of Evidence for Directly Testing Financial Statement Items. Evidence-gathering is the core of the audit. Auditing is a process of gathering evidence to test assertions. Why do we need audit evidence? Minimize audit risk.

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Chapter 7

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  1. Chapter 7 Direct Tests of Account Balances

  2. Overview of Evidence for Directly Testing Financial Statement Items • Evidence-gathering is the core of the audit. • Auditing is a process of gathering evidence to test assertions. • Why do we need audit evidence? • Minimize audit risk. • Support the opinion.

  3. Evidence The Second Standard of Fieldwork: Sufficient, competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit.

  4. Assertions • Existence or occurrence • Completeness • Rights and obligations • Valuation or allocation • Presentation and disclosure

  5. Approach to Gathering Evidence • Factors to consider: • management integrity • client economic risk • quality of the client’s information system • client’s control structure • current market conditions and competitor actions

  6. 1 Understand the client and the industry. 2 Assess environment risk. Directly test transactions and/or account balances. 3 4 Assess adequacy of evidence. Important steps in the audit process

  7. Nature of Audit Testing Two basic types of audit evidence: • The underlying accounting data. • Corroborating information that validates • the underlying accounting data.

  8. Audit Procedures • Audit procedures vary according to the risk. • Vary with the three major phases of the audit. • Preliminary planning and risk analysis. • Understand and test system. • Test account balances or other business measurements.

  9. Reliability of Evidence • More Reliable: • Directly observable evidence. • Evidence derived from a well-controlled information system. • Evidence from independent outside sources.

  10. Reliability of Evidence • Less Reliable: • Indirectly observable evidence. • Evidence derived from a poorly controlled or easily overridden information system. • Evidence from within the client’s organization.

  11. Internal Documentation • Reliability varies with: • Quality of internal control. • Fraud potential. • Formality of the organization. • Preparation of the document independently of the accounting system and management.

  12. External Documentation Generally considered to be highly reliable. More reliable if auditor receives directly.

  13. Paper vs. Electronic Major challenge for auditors to determine which electronic data is reliable. Computer systems can be designed to provide safeguards. Auditor must continually examine nature of evidence.

  14. Directional Testing • Test for over- or understatement, not both. • Efficient because: • Misstatements are more likely to occur in one direction. • Can provide evidence about a complementary set of accounts. • Some assertions are directional by nature.

  15. Direct Tests of Account Balances • Types of Audit Procedures: • Observation • Physical examination • Inquiries of client personnel • Inquires of outside parties • Examination of documents • Recomputation or recalculation

  16. Direct Tests of Account Balances (cont.) • Reprocessing transactions • Vouching of transactions • Analytical procedures

  17. Timing and Extent of Procedures • Auditor must determine when to do the procedure: • as of the balance sheet date • after the balance sheet date • at an interim date Timing decisions based on: risk, internal control, nature of the account and availability of audit staff.

  18. Audit Programs and Documenting Evidence Audit programs Specify procedures to be used. Specify how much evidence to gather. Specify which population to audit.

  19. Documenting Audit Evidence • Audit working papers include: • Evidence of planning, including the audit program. • The client’s trial balance. • Copies of selected internal/external documents. • Auditor memos. • Computer printouts of analysis and tests of clients controls. • Auditor-generated analysis of account balances.

  20. Characteristics of Good Audit Working Papers • A heading. • Initials or signature of auditor. • Initials or signature of reviewer. • Description of work performed. • Assessment of evidence. • Tic marks and legend. • Index. • Cross references to related work papers.

  21. Other Topics • Paper vs. Electronic Working Papers. • Importance of quality review.

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