Evidence and Documentation

Chapter 5

Evidence and Documentation

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

LO# 5

Management AssertionsFinancial statements issued by management contain

explicit and implicit assertions. Table 5-1

2-2

Relationship of AuditEvidence to the Audit Report

Management assertionsabout components offinancial statements

Financialstatements

Auditprocedures

Auditreport

Provide evidence on thefairness of the

financial statements

LO# 1

Auditor reaches a conclusion based

on the evidence

5-3

Audit Evidence

All the information, from whatever source, used

by the auditor in arriving atthe conclusions on which the

audit opinion is based.

LO# 3

5-4

The Concepts of AuditEvidence

Nature of audit evidence

Sufficiency and appropriateness of audit evidence

Evaluation of audit evidence

LO# 3

5-5

Nature of Audit EvidenceRecords of

initial entries andsupporting records

Invoices ContractsGeneral

and subsidiaryledgers

Adjustmentsto financialstatements Worksheets

Spreadsheetssupporting cost

allocations

Othercomputations,

reconciliations, anddisclosures

LO# 3

5-6

Sufficiency ofAudit Evidence

Sufficiency is the measure ofthe quantity of audit evidence.

Greater risk ofmisstatement requires

a higher quantityof audit evidence.

Higher quality audit evidence results

in a lower quantityof audit evidence.

LO# 3

5-7

Appropriateness ofAudit Evidence

Relevance

Reliability

Independent source of the evidence

Effectiveness of internal control

Auditor’s direct personal knowledge

Documentary evidence

Original documents

LO# 3

Appropriateness is a measureof the quality of audit evidence.

5-8

Evaluation ofAudit Evidence

Proper evaluation of evidencerequires an understanding of the:

Types of evidence available.

Relative reliability of available evidence.

An auditor should be thorough in searchingfor evidence and unbiased in its evaluation.

LO# 3

5-9

Audit Procedures

Specific actsperformed by the auditorto gather evidence about

whether specific assertions are being met.

Risk assessment procedures

Test of controls

Substantiveprocedures

LO# 4

5-10

Audit Procedures

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

statements is referred to as an audit program.

Management Assertions Examples of Audit ProceduresExistence Confirm receivables.Rights and obligations Inquire if receivables have been sold or pledged.Completeness Agree controlling account with total of subsidiary accounts.

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 Program for Accounts Receivable

LO# 4

5-11

Audit Procedures forObtaining Audit Evidence

Inspectionof records and

documents

Evidence obtained fromexternal documents is more

reliable than evidence obtainedfrom internal documents.

Journal orLedger

SourceDocuments

Vouching(Occurrence)

Tracing(Completeness)

LO# 4

5-12


The process of watching a process or procedure being performed by others.

Observation

Inspectionof tangible

assets

Physical examination of a tangible asset.

LO# 4

5-13


In conducting inquiry, the auditor should:• Consider the knowledge, objectivity,

experience, responsibility, and qualifications of the individual to be questioned.

• Ask clear, concise, and relevant questions.

• Use open or closed questions appropriately.

• Listen actively and effectively.• Consider the reactions and responses,

then ask follow-up questions.• Evaluate the response.

Inquiry

LO# 4

5-14


ExternalConfirmation

LO# 4

The reliability of evidence obtained through confirmations is directly affected by factors such as:– The form of the confirmation.– Prior experience with the entity.– The nature of the information being confirmed.– The intended respondent.

The process of obtaining a representation of information or of an existing condition directly from a third party.

5-15


ExternalConfirmation

LO# 4

5-16


Determining the mathematical accuracy of documents or records.

Reperformance

Recalculation

The auditor’s independent execution of procedures or controls that were originally performed as part of the internal control system.

LO# 4

5-17


Review of accounting data to identify significant or unusual items.

Scanning

Analyticalprocedures

Evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data.

LO# 4

5-18

Reliability of Typesof Evidence

LO# 5

5-19

Purposes of Analytical ProceduresPreliminary Analytical

Procedures (Risk Assessment Procedures)

Used to assist the auditor to better understand the business and to plan the

nature, timing, and extent of audit procedures.

Substantive Analytical

Procedures

Used to obtain evidential matter about particular assertions related to account

balances or classes of transactions.

Final Analytical

Procedures

Used as an overall review of the financial information in the final review stage of the

audit.

LO# 9

5-20

Types of Analytical Procedures(See Table 5-10)

Trend Analysis

Ratio Analysis

Reasonableness

Analysis

LO# 9

5-21

Substantive Analytical Procedures Decision Process

Figure 5-7 Overview of the Auditor’s Decision Process for Substantive Analytical Procedures

LO# 9

5-22

Develop an Expectation Auditing standards require the auditor to have an expectation

whenever analytical procedures are used. An expectation can be developed using a variety of information sources such as:

• Financial and operating data.• Budgets and forecasts.• Industry publications.• Competitor information.• Management’s analyses. • Analyst’s reports.

LO# 9

5-23

Define a Tolerable DifferenceThe size of the tolerable difference depends on:

• the significance of the account; • the desired degree of reliance on the substantive

analytical procedures; • the level of disaggregation in the amount being tested;

and • the precision of the expectation.But the amount is always less than planning materiality!

LO# 9

5-24

Compare and Investigate

Compare the expectation to the recorded amount and investigate any differences greater than the

tolerable difference.

LO# 9

5-25

Investigate Differences for Risk Assessment and Final Analytical Procedures

Preliminary Analytical

Procedures (Risk Assessment Procedures) Differences

Corroborating evidence

is not required

Final Analytical

Procedures Differences

Corroborating evidence

is required

LO# 9

5-26

Audit Testing HierarchyFigure 5-3 Audit Testing Hierarchy: An Evidence Decision Process for Testing

Significant Balances or Classes of Transactions

LO# 6

5-27

Filling the Assurance BucketLO# 6

5-28

Example of Filling the Assurance Buckets for Each Assertion (Accounts Payable)

LO# 6

5-29

Audit DocumentationThe auditor’s principal record of the

audit procedures performed, evidence obtained, and conclusions reached.

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

LO# 7

5-30

Content of AuditDocumentation

Audit documentation should:

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

Support the basis for the auditor’s conclusions concerning each material financial statement assertion.

Demonstrate that the underlying accountingrecords agreed or reconciled with the financial statements.

LO# 8

5-31


Audit documentation should:

Include a written audit program detailing auditingprocedures necessary to accomplish audit objectives.

Enable a knowledgeable and experienced reviewer to:

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

procedures, evidence obtained,and conclusions reached.

Determine who performedand reviewed the work,

as well as the datesof the work and reviews.

LO# 8

5-32


Most public accounting firms maintainaudit documentation in two types of files:

Permanent files Current files

Corporate charter Important contractsChart of accounts Internal control documentationOrganization chart Terms of stock and bond issuesAccounting manual Prior years’ analytical procedures

LO# 8

5-33


Most public accounting firms maintainaudit documentation in two types of files:

Permanent files Current files

Audit plan, audit report Adjusting journal entriesAudit programs Reclassification journal entriesWorking trial balance Current financial statementsMinutes of meetings Working papers supporting accounts

LO# 8

5-34

Format of Audit Documentation

Heading (Exhibit 5-2, p. 153)

Indexing andcross-referencing

(Figure 5-6, p. 155)

Tick marks(Exhibit 5-2, p. 153)

Client nameTitle of the working paper

Client’s year-end date

Notations that provide a trailfrom financial statements to

audit documents.

Notations made next towork paper items indicating

auditor/reviewer actions.

LO# 8

5-35

Audit Documentation Audit Plan

– Overall strategy for audit (e.g. understanding client, risks, accounts, audit hours)

Audit Program– Audit procedures to be performed; for example, one

program for each business process and/or account Working Trial Balance

– Exhibit 5-1 (p. 152) – adjustments ($ changes); reclassification (changes in classification of accounts)

Account Analysis– Exhibit 5-2 (p. 153) – activities in account

Account Listing (Lead Schedule)– Figure 5-6 (p. 155) – items left in ending balance

Audit Memoranda– Documents auditor’s work; e.g. errors identified,

discussions with clients

Audit Documentation

Audit documentation should be organized sothat audit team members and others can find

evidence supporting financial statement accounts.

All audit documentation is the property of theauditor, including documents preparedby the client at the auditor’s request.

The Sarbanes-Oxley Act of 2002 requiresaudit documentation to be retained for seven

years from the completion date of the engagement.

LO# 8

5-37