Chapter 4Chapter 4

Audit Evidence and Audit Documentation

Obj iObjectives

Understand the relationship between audit evidence • Understand the relationship between audit evidence and the auditor’s report

d d h i b l• Understand the management assertions about classes of transactions and events, account balances at the period end, presentation and disclosure

• Learn the basic concepts of audit evidence

• Understand audit procedures used for obtaining audit evidence

• Understand the objectives of audit documentation

Relationship of AuditEvidence to the Audit Report

Financialstatements

Auditreport

Management assertionsb t t f

Auditor reaches l i b dabout components of

financial statementsa conclusion based

on the evidence

Auditd

Provide evidence on thefairness of theprocedures financial statements

WHAT ARE ASSERTIONS?

• Management is responsible for the fair presentation of the financial statements.presentation of the financial statements.

• Assertions are expressed or implied p prepresentations by management regarding the recognition, measurement, presentation, and d l f f h fi ldisclosure of information in the financial statements and related disclosures (AU 326.14).

Management Assertions Management Assertions Classification

1. Assertions about classes of transactions and events for the period under audit events for the period under audit.

2. Assertions about account balances at the period end. period end.

3. Assertions about presentation and disclosure.

Management AssertionsManagement Assertions

• Illustration: the financial statements show a net sales figure of $10 million management net sales figure of $10 million management asserts that▫ the sales exist (existence assertion)the sales exist (existence assertion)▫ all sales conducted within the current time frame

(cutoff assertion)▫ recorded in their correct amounts (accuracy

assertion)

Assertions about Classes of Transactions & Events during the Periodg

1. Authorization2 Accuracy2. Accuracy3. Completeness4 Classification4. Classification5. Cutoff6 Occurrence6. Occurrence

Assertions about Account Balances at the Period End

1 Completeness1. Completeness

2. Existence

3. Rights and Obligations

V l ti d All ti4. Valuation and Allocation

Assertions about Presentation and Disclosure

1. Completeness

2. Occurrence and Rights and Obligations

Cl ifi ti d U d t d bilit3. Classification and Understandability

4. Accuracy and Valuation

Management Assertions

Audit ProceduresAudit Procedures

S ifi tSpecific actsperformed by the auditorto gather evidence about to gather evidence about

whether specific assertionsare being met.g

Risk assessmentprocedures

Test of controls

Substantiveproceduresprocedures controls procedures

Audit Procedures

i k d• Risk assessment procedures• Obtain an understanding of the entity and its environment, including its

internal control, to assess the risks of material misstatement at the financial statement and relevant assertion levels.

• Test of controls• Test of controls• Test the operating effectiveness of controls in preventing or detecting

material misstatements at the relevant assertion level.

• Substantive procedures• Detect material misstatements at the relevant assertion level, including

tests of details of classes of transactions, account balances and disclosures, and substantive analytical procedures

Audit ProgramAudit Program

A set of audit procedures prepared to testA set of audit procedures prepared to testassertions for a component of the financial

statements is referred to as an audit program.p g

Management Assertions Examples of Audit ProceduresAudit Program for Accounts Receivable

g pExistence Confirm receivables.Rights and obligations Inquire if receivables have been sold or pledged.Completeness Agree controlling account with total of subsidiary accounts. p g g y

Select shipping documents immediatley prior to year end and ensure sales invoices were recorded.

Valuation or allocation Trace accounts from aged trial balance to subsidiary accounts.Test the adequacy of the allowance account.

Presentation and disclosure Look for amounts due from related parties.Evaluate receivables for footnote disclosure.

Audit evidence

All the information from whatever source used • All the information, from whatever source, used by the auditor to support his/her audit opinion.

• Auditors gather evidence by conducting Audit Procedures to TEST MANAGEMENT ASSERTIONS.

3 Concepts of Audit Evidence3 Concepts of Audit Evidence

Nature of audit evidence

Sufficiency and appropriateness of audit evidence

Evaluation of audit evidence

N f A di E idNature of Audit Evidence• The nature of the evidence refers to the form or

type of information including

accounting records▫ the records of initial entries and supporting

drecords

other available informationother available information▫ minutes of meetings; ▫ confirmations from third parties;co at o s o t d pa t es;▫ industry analysts’ reports;▫ etc…

What types of EVIDENCE must be What types of EVIDENCE must be collected?

• Collect SUFFICIENT and APPROPRIATE evidence.▫ Sufficiency is the measure of the quantity of audit evidencey q y

▫ Appropriateness is a measure of the quality of audit

evidenceevidence

GREATER RISK i HIGHER QUANTITY f dit GREATER RISK requires HIGHER QUANTITY of audit

evidence

HIGHER QUALITY audit evidence RESULTS in a LOWER

QUANTITY of audit evidence

When is evidence considered APPROPRIATE?

Evidence is considered appropriate when it provides pp p pinformation that is both relevant and reliable

Relevance▫ How the evidence is related to the assertion or to the objective of

the control being tested. (Relates to whatever you are testing)g ( y g)

• Illustration▫ To check the completeness assertion for recording sales

transactions ▫ Are all goods shipped to customers are recorded in the sales

j ljournal? trace a sample of shipping documents to the related sales

invoices and entries in the sales journal

When is evidence considered APPROPRIATE?

li biliReliability• If a particular type of evidence can be relied upon to signal the true state

of an assertion.

▫ Knowledgeable independent source of the evidence

Evidence obtained directly by the auditor from a knowledgeable

independent source outside the entity is more reliable than evidence

obtained solely from within the entityobtained solely from within the entity

▫ Effectiveness of internal control.

If the client’s internal control is assessed effective, ,evidence generated by f ff , , g y

that accounting system is viewed as reliable

When is evidence considered APPROPRIATE?

R li bilitReliability▫ Auditor’s direct personal knowledge

E id b i d di l b h di i ll id d Evidence obtained directly by the auditor is generally considered to

be more reliable than evidence obtained indirectly or by inference

D t id▫ Documentary evidence

Audit evidence is more reliable when it exists in documentary

formform

▫ Original documents

Audit evidence provided by original documents is more reliable Audit evidence provided by original documents is more reliable

than audit evidence provided by photocopies or facsimiles

QuestionQ

• Which of the following sources of evidence are more Which of the following sources of evidence are more reliable:

1. Inquiry of an accounts receivable clerk regarding the acco nts recei able balance or acco nts the accounts receivable balance or accounts receivable confirmations sent to a sample of customers.

2. Physical examination of lumber inventory performed by the external auditor or physical examination of inventory performed by internal examination of inventory performed by internal auditors.

E l ti f dit idEvaluation of audit evidence

A di h ld b h h i hi f An auditor should be thorough in searching for

evidence and unbiased in its evaluation.

ll i Illustration:

If auditor decides to mail accounts receivable confirmations to 50 of the largest

f li h h ffi i id h f hcustomers of a client, he must gather sufficient evidence on each of the 50 accounts

In evaluating a client’s response to an audit inquiry the auditor must not allow anyIn evaluating a client s response to an audit inquiry, the auditor must not allow any

personal factors to influence the evaluation of the client’s response

Audit Procedures forAudit Procedures forObtaining Audit Evidence

• Evidence is commonly categorized into the • Evidence is commonly categorized into the following types:

1. Inspection of records or documents 2. Inspection of tangible assets 3. Observation 4. Inquiry 5 Confirmation5. Confirmation6. Recalculation 7. Reperformance8. Analytical procedures 9. Scanning

Audit Procedures forAudit Procedures forObtaining Audit EvidenceInspection of records or documents

• Inspection consists of examining internal or • Inspection consists of examining internal or

external records or documents that are in paper

form, electronic form, or other media

▫ the reliability of such evidence ▫ the reliability of such evidence

▫ its relationship to specific assertions

Audit Procedures forAudit Procedures forObtaining Audit Evidence

Inspection of tangible assetsphysical examine of the assetsp y

Observation observe a process or procedure being performed by others

Inquiry seek information of knowledgeable persons (both fi nancial

d fi i l) h h h i id h and nonfi nancial) throughout the entity or outside the entity

Audit Procedures forAudit Procedures forObtaining Audit EvidenceConfirmation

obtaining a representation of information or of an g pexisting condition directly from a third party

Recalculationchecking the mathematical accuracy of documents or records.

ReperformanceReperformanceindependent execution by the auditor of procedures or controls that were originally performed by company controls that were originally performed by company personnel

Audit Procedures forAudit Procedures forObtaining Audit EvidenceAnalytical procedures

- an important type of evidence on an auditp yp- evaluations of financial information made by a study of plausible relationships among both fi nancial and nonfi nancial data

iScanningreview of accounting data to identify i ifi t l itsignificant or unusual items

Audit Procedures forAudit Procedures forObtaining Audit Evidence

Audit Procedures

Audit DocumentationAudit Documentation

The auditor’s principal record of thep paudit procedures performed, evidence

obtained, and conclusions reached.

Audit documentation (working papers) have two functions:Audit documentation (working papers) have two functions: To provide support for the audit report. To aid in the planning, performance, and supervision of

the auditthe audit.

Content of Audit DocumentationContent of Audit Documentation

Audit documentation should:Audit documentation should:

Demonstrate how the audit complied with auditing Demonstrate how the audit complied with auditing and related professional practice standards.

Support the basis for audit conclusions concerningeach material financial statement assertion.

Demonstrate that the underlying accountingrecords agreed with the financial statements.

Content of Audit DocumentationContent of Audit Documentation

Audit documentation should:Audit documentation should:

Include a written audit program detailing auditingd t li h dit bj tiprocedures necessary to accomplish audit objectives.

Enable a knowledgeable and experienced reviewer to:Enable a knowledgeable and experienced reviewer to:

Understand the nature, timing,extent, and results of audit

procedures, evidence obtained,

Determine who performedand reviewed the work,

as well as the datesp o d , d ob d,and conclusions reached.

dof the work and reviews.

Homework

• PR 4-24PR 4 25• PR 4-25

• PR 4-28• PR 4 32• PR 4-32

• GROUP ASSIGNMENT : Earth Wear Case –• GROUP ASSIGNMENT : Earth Wear Case page 140