6 - 1 Copyright 2003 Pearson Education Canada Inc. CHAPTER 6 Audit Evidence

CHAPTER 6 AuditEvidence

An auditor must address An auditor must address four decisionsfour decisions regarding regarding evidence accumulationevidence accumulation::

Which audit procedures Which audit procedures should be used?should be used?

Whatare audit

procedures?

An audit procedure is a detailed

instruction for thecollection of a type of

audit evidence.

In general, the auditor will seekthe most appropriate procedures

that are also cost-feasible.

MORE LESS

What sample size should What sample size should be selected?be selected?

Which items should be Which items should be selected for testing?selected for testing?

The auditor will consider:- random/judgmental selection

The auditor will consider:- random/judgmental selection- materiality

The auditor will consider:- random/judgmental selection- materiality- results of prior audits

When should the procedures When should the procedures be performed?be performed?

December

When should the procedures When should the procedures be performed?be performed?

The auditor will consider proceduresthat should be performed before, on,

or after the balance sheet date.

December

When should the procedures be When should the procedures be performed?performed?

Which items should be selected Which items should be selected for testing?for testing?

What sample size should be What sample size should be selected?selected?

Which audit procedures should Which audit procedures should be used?be used?

When should the procedures be performed?When should the procedures be performed?

After these questions have been answered and the specific audit objectives have been identified, an audit program is constructed.

Which items should be selected for testing?Which items should be selected for testing?

What sample size should be selected?What sample size should be selected?

Which audit procedures should be used?Which audit procedures should be used?

Whatis an auditprogram?

An auditprogram is a list of

detailed audit procedures for each component or cycle specifying proce-

dure timing, sample sizes, and selection methods.

PersuasivenessPersuasiveness of evidence is of evidence is determined by:determined by:

relevance

timeliness

sufficiency

appropriate-ness

PersuasivenessPersuasiveness of evidence is of evidence is determined by:determined by:

relevance

timeliness

sufficiency

appropriate-ness

Which ofthese are

specificallymentioned in the 3rd

examinationstandard?

sufficiency

appropriate-ness

Which ofthese are

specificallymentioned in the 3rd

examination standard?

relevance

Evidence must pertain to the Evidence must pertain to the specific audit objective.specific audit objective.

relevance

Example: An auditor is concerned aboutthe completeness of accounts payable(a/p). Why would confirmation of a/p bal-ances be an irrelevant procedure?

Evidence must pertain to the Evidence must pertain to the specific audit objective.specific audit objective.

relevance

Example: An auditor is concerned aboutthe completeness of accounts payable(a/p). Why would confirmation of a/p bal-ances be an irrelevant procedure?

Confirmation addresses existence.For completeness, a search is needed.

appropriate-ness

Appropriateness concerns the Appropriateness concerns the believabilitybelievability and and trustworthi-trustworthi-

nessness of the evidence. of the evidence.

appropriate-ness

Appropriateness is determined by:Appropriateness is determined by:- independence of the evidence provider

Appropriateness Appropriateness concerns the concerns the

believabilitybelievability and and trustworthinesstrustworthinessof the evidence.of the evidence.

appropriate-ness

Appropriateness is determined by:Appropriateness is determined by:- independence of the evidence provider- effectiveness of client’s internal controls

appropriate-ness

Appropriateness is determined by:Appropriateness is determined by:- independence of the evidence provider- effectiveness of client’s internal controls- auditor’s direct knowledge

appropriate-ness

Appropriateness is determined by:Appropriateness is determined by:- independence of the evidence provider- effectiveness of client’s internal controls- auditor’s direct knowledge- qualifications of information provider

appropriate-ness

Appropriateness is determined by:Appropriateness is determined by:- independence of the evidence provider- effectiveness of client’s internal controls- auditor’s direct knowledge- qualifications of information provider- degree of objectivity

appropriate-ness

Appropriateness is a measure of Appropriateness is a measure of evidence evidence qualityquality, it can, it cannotnot be be enhanced by a larger sample enhanced by a larger sample

size.size.

sufficiency

Sufficiency is a measure of Sufficiency is a measure of quantityquantity. In general, the . In general, the largerlarger

the sample size, the the sample size, the more more persuasivepersuasive the evidence. the evidence.

Less evidence yields

less assurance and

lower auditcosts.

More evidence yields

more assurance and

higher audit costs.

MORE LESS

Auditors must balance the trade-off be-Auditors must balance the trade-off be-tween gathering more or less evidence.tween gathering more or less evidence.

sufficiency

SufficiencySufficiency must be addressed for must be addressed foreach audit test and each componenteach audit test and each component

of the financial statements.of the financial statements.

An appropriate sample size may be An appropriate sample size may be determined by auditor determined by auditor judgmentjudgment

and/or by and/or by statistical samplingstatistical sampling..

sufficiency

SufficiencySufficiency must be addressed for must be addressed foreach audit test and each componenteach audit test and each component

of the financial statements.of the financial statements.

sufficiency

In determining a sufficient sampleIn determining a sufficient samplesize, an auditor will also consider:size, an auditor will also consider:- “representativeness”

sufficiency

- “representativeness”- materiality, large dollar amounts

In determining a sufficient sampleIn determining a sufficient samplesize, an auditor will also consider:size, an auditor will also consider:

sufficiency

- “representativeness”- materiality, large dollar amounts- items with high probability of misstatement

In determining a sufficient sampleIn determining a sufficient samplesize, an auditor will also consider:size, an auditor will also consider:

timeliness

When should auditWhen should auditevidence be gathered?evidence be gathered?

timeliness

When should auditWhen should auditevidence be evidence be gathered?gathered?

- evidence related to balance sheet accounts should be collected as close to the balance sheet date as possible

timeliness

When should auditWhen should auditevidence be evidence be gathered?gathered?

- evidence related to balance sheet accounts should be collected as close to the balance sheet date as possible- evidence related to income statement accounts should be collected from throughout the period rather than from only part of the period

relevance

timeliness

sufficiency

appropriate-ness

Evidence isconsideredpersuasiveonly if all

four determinants

have been met.

With regard to the adequacy With regard to the adequacy and costs of audit evidenceand costs of audit evidence::

absolutecertainty

convincingevidence

requires

absolutecertainty

convincingevidence

high auditcosts

requires

absolutecertainty

convincingevidence

high auditcosts

requires

reasonablecertainty

persuasiveevidence

requires

absolutecertainty

convincingevidence

high auditcosts

requires

reasonablecertainty

persuasiveevidence

reasonableaudit costs

Types of evidence Types of evidence - physical examination - inspection or count by the auditor of a tangible asset

veryvery appropriate evidence! appropriate evidence!

auditor

client’s customer

- physical examination - confirmation - receipt of a written or oral response from an independent third party at the auditor’s request

veryvery appropriate evidence! appropriate evidence!

Types of evidence Types of evidence

Canada 46

The confirmationprocess must be controlled

by the auditor.

- physical examination - confirmation - receipt of a written or oral response from an independent third party at the auditor’s request

Whenever reasonable,a sample of accounts receivable

should be confirmed by theauditor.

- physical examination - confirmation - receipt of a written response from an independent third party at the auditor’s request

- physical examination - confirmation - documentation (vouching) - auditor examination of client documents and records

What is the difference What is the difference between between internalinternal and and external documentsexternal documents??

External documents are usually on theclient’s premises but were either pre-pared by a third party or processedby a third party (more persuasive).

Internal documents have beenprepared by the client and have

not left the client’s premises(less persuasive).

What is the primary What is the primary determinant of the determinant of the appropriateness of appropriateness of

internal documentsinternal documents??

What is the primary What is the primary determinant of the determinant of the appropriateness of appropriateness of

internal internal documentsdocuments??

internalinternalcontrolcontrol

- physical examination - confirmation - documentation

What is the difference What is the difference between between physicalphysicalexaminationexamination and and documentationdocumentation??

Types of evidenceTypes of evidence

- documentation (vouching) - auditor examination of client documents and records

- physical examination - inspection or count by the auditor of a tangible asset

What is the difference What is the difference between between physicalphysicalexaminationexamination and and documentationdocumentation??

- physical examination - confirmation - documentation (vouching)- observation - using the senses to audit; often an informal procedure requiring follow-up procedures

- physical examination - confirmation - documentation (vouching)- observation - inquiries of client - useful but biased and not persuasive unless supported by another form of evidence

- physical examination - confirmation - documentation (vouching)- observation - inquiries of client - reperformance - checking the accuracy of client calculations and transfers of information (often performed by an audit software package).

- physical examination - confirmation - documentation (vouching)- observation - inquiries of client - reperformance - analytical procedures - involve analy- sis of comparisons and interrelation- ships in data (may be performed by an audit software package).

Analytical procedures Analytical procedures should be used during the should be used during the planningplanning and and completioncompletion

phases of the audit...phases of the audit...

Analytical procedures Analytical procedures should be used during the should be used during the planningplanning and and completioncompletion

phases of the audit...phases of the audit...

butbut they may they may alsoalso be bebeneficial at otherbeneficial at other

times during the audit.times during the audit.

Purposes of Analytical ProceduresPurposes of Analytical Procedures

- facilitate understanding of client’s business and industry

- facilitate understanding of client’s business and industry- may indicate financial difficulty and the client’s ability to continue as a going concern

Bert’s Boutique

Going Out o

f Business Sale!

- facilitate understanding of client’s business and industry- may indicate financial difficulty and the client’s ability to continue as a going concern- may indicate misstatements in the financial statements

- facilitate understanding of client’s business and industry- may indicate financial difficulty and the client’s ability to continue as a going concern- may indicate misstatements in the financial statements- may result in a reduction of detailed audit tests

- industry comparisons

Types of Analytical ProceduresTypes of Analytical Procedures

How do theclient’s financial ratios

compare with thoseof the industry?

- industry comparisons - comparisons with prior years

AceCompany

2003financial

statements

AceCompany

2004financial

statements

- industry comparisons - comparisons with prior years

AceCompany

2003financial

statements

Conclusions from a 2-year analy-Conclusions from a 2-year analy-sis may be erroneous. sis may be erroneous. WHYWHY??

AceCompany

2004financial

statements

- industry comparisons - comparisons with prior years- comparisons with client-determined expected results, e.g.,

budgetsbudgets

account can be calculated from sales commissions ?????????????????

- industry comparisons - comparisons with prior years- comparisons with client-determined expected results- comparisons with auditor-determined expected results, examples:

account can be calculated from sales commissions sales depreciation expense ??????????????????

account can be calculated from sales commissions sales depreciation expense fixed assets interest expense ??????????????????

account can be calculated from sales commissions sales depreciation expense fixed assets interest expense notes/bonds payable

Types of Analytical ProceduresTypes of Analytical Procedures- industry comparisons - comparisons with prior years- comparisons with client-determined expected results- comparisons with auditor-determined expected results- comparisons with expected results, using nonfinancial data, example:

account can be calculated fromequipment maintenance expense ???????

Types of Analytical ProceduresTypes of Analytical Procedures- industry comparisons - comparisons with prior years- comparisons with client-determined expected results- comparisons with auditor-determined expected results- comparisons with expected results, using nonfinancial data, example:

account can be calculated fromequipment maintenance expense production

Analytical proce-dures are oftenfacilitated by

audit software.

If analytical procedures If analytical procedures disclose unusual fluc-disclose unusual fluc-tuations or variances, tuations or variances, the auditor should the auditor should in-in-vestigatevestigate by gathering by gatheringadditional evidence.additional evidence.

If analytical procedures If analytical procedures disclose unusual fluc-disclose unusual fluc-tuations or variances, the tuations or variances, the auditor should auditor should investigateinvestigateby gathering additional by gathering additional evidence.evidence.

The auditor should con-The auditor should con-sider whether fluctua-sider whether fluctua-tions or variances are tions or variances are materialmaterial and whether they and whether they may be may be reasonablyreasonablyjustifiablejustifiable..

6 - 1 Copyright 2003 Pearson Education Canada Inc. CHAPTER 6 Audit Evidence

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