Chapter 6 Audit Evidence

CHAPTER 6 Audit Evidence Copyright 2003 Pearson Education Canada Inc.

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An auditor must address four decisions regarding evidence accumulation:

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An auditor must address four decisions regarding evidence accumulation:

Which audit procedures should be used?

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Which audit procedures should be used?

What are audit procedures? Copyright 2003 Pearson Education Canada Inc.

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Which audit procedures should be used? An audit procedure is a detailed instruction for the collection of a type of audit evidence. Copyright 2003 Pearson Education Canada Inc.

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Which audit procedures should be used? In general, the auditor will seek the most appropriate procedures that are also cost-feasible.

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An auditor must address four decisions regarding evidence accumulation: MORE LESS

What sample size should be selected? Copyright 2003 Pearson Education Canada Inc.

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An auditor must address four decisions regarding evidence accumulation:

Which items should be selected for testing?

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Which items should be selected for testing? The auditor will consider: - random/judgmental selection Copyright 2003 Pearson Education Canada Inc.

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Which items should be selected for testing?

The auditor will consider: - random/judgmental selection - materiality Copyright 2003 Pearson Education Canada Inc.

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Which items should be selected for testing? The auditor will consider: - random/judgmental selection - materiality - results of prior audits Copyright 2003 Pearson Education Canada Inc.

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An auditor must address four decisions regarding evidence accumulation:

When should the procedures be performed? December

? Copyright 2003 Pearson Education Canada Inc.

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When should the procedures be performed? December

The auditor will consider procedures that should be performed before, on, or after the balance sheet date. Copyright 2003 Pearson Education Canada Inc.

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An auditor must address four decisions regarding evidence accumulation: Which audit procedures should be used? What sample size should be selected? Which items should be selected for testing?

When should the procedures be performed? Copyright 2003 Pearson Education Canada Inc.

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Which audit procedures should be used? What sample size should be selected? Which items should be selected for testing?

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. Copyright 2003 Pearson Education Canada Inc.

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

What is an audit program? Copyright 2003 Pearson Education Canada Inc.

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

An audit program is a list of detailed audit procedures for each component or cycle specifying procedure timing, sample sizes, and selection methods. Copyright 2003 Pearson Education Canada Inc.

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Persuasiveness of evidence is determined by: relevance

sufficiency

appropriateness

timeliness

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Persuasiveness of evidence is determined by: relevance

sufficiency

appropriateness

timeliness

Which of these are specifically mentioned in the 3rd examination standard? Copyright 2003 Pearson Education Canada Inc.

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sufficiency

appropriateness

Which of these are specifically mentioned in the 3rd examination standard?

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relevance

Evidence must pertain to the specific audit objective. Copyright 2003 Pearson Education Canada Inc.

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Evidence must pertain to the specific audit objective. relevance

Example: An auditor is concerned about the completeness of accounts payable (a/p). Why would confirmation of a/p balances be an irrelevant procedure? Copyright 2003 Pearson Education Canada Inc.

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relevance

Example: An auditor is concerned about the completeness of accounts payable (a/p). Why would confirmation of a/p balances be an irrelevant procedure? Confirmation addresses existence. For completeness, a search is needed. Copyright 2003 Pearson Education Canada Inc.

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appropriateness

Appropriateness concerns the believability and trustworthiness of the evidence. Copyright 2003 Pearson Education Canada Inc.

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appropriateness

Appropriateness concerns the believability and trustworthiness of the evidence.

Appropriateness is determined by: - independence of the evidence provider

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appropriateness

Appropriateness concerns the believability and trustworthiness of the evidence.

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

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appropriateness

Appropriateness concerns the believability and trustworthiness of the evidence.

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

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appropriateness

Appropriateness concerns the believability and trustworthiness of the evidence.

Appropriateness is determined by: - independence of the evidence provider - effectiveness of client’s internal controls - auditor’s direct knowledge - qualifications of information provider Copyright 2003 Pearson Education Canada Inc.

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appropriateness

Appropriateness concerns the believability and trustworthiness of the evidence.

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 Copyright 2003 Pearson Education Canada Inc.

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appropriateness

Appropriateness concerns the believability and trustworthiness of the evidence.

Appropriateness is a measure of evidence quality, it cannot be enhanced by a larger sample size. Copyright 2003 Pearson Education Canada Inc.

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sufficiency

Sufficiency is a measure of quantity. In general, the larger the sample size, the more persuasive the evidence. Copyright 2003 Pearson Education Canada Inc.

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MORE

LESS

More evidence yields more assurance and higher audit costs.

Less evidence yields less assurance and lower audit costs.

Auditors must balance the trade-off between gathering more or less evidence. Copyright 2003 Pearson Education Canada Inc.

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sufficiency

Sufficiency must be addressed for each audit test and each component of the financial statements. Copyright 2003 Pearson Education Canada Inc.

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sufficiency

Sufficiency must be addressed for each audit test and each component of the financial statements. An appropriate sample size may be determined by auditor judgment and/or by statistical sampling. Copyright 2003 Pearson Education Canada Inc.

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sufficiency

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

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sufficiency

In determining a sufficient sample size, an auditor will also consider: - “representativeness” - materiality, large dollar amounts

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sufficiency

In determining a sufficient sample size, an auditor will also consider: - “representativeness” - materiality, large dollar amounts - items with high probability of misstatement Copyright 2003 Pearson Education Canada Inc.

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timeliness

When should audit evidence be gathered? Copyright 2003 Pearson Education Canada Inc.

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timeliness

When should audit evidence be gathered?

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

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timeliness

When should audit evidence be 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 Copyright 2003 Pearson Education Canada Inc.

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relevance

sufficiency

appropriateness

timeliness

Evidence is considered persuasive only if all four determinants have been met.

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With regard to the adequacy and costs of audit evidence: absolute certainty

requires convincing evidence Copyright 2003 Pearson Education Canada Inc.

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With regard to the adequacy and costs of audit evidence: absolute certainty requires convincing evidence requires high audit costs

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With regard to the adequacy and costs of audit evidence: absolute certainty requires convincing evidence requires high audit costs

reasonable certainty requires persuasive evidence

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With regard to the adequacy and costs of audit evidence: absolute certainty requires

reasonable certainty requires

convincing evidence requires

persuasive evidence requires

high audit costs

reasonable audit costs Copyright 2003 Pearson Education Canada Inc.

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

very appropriate evidence! Copyright 2003 Pearson Education Canada Inc.

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

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client’s customer

very appropriate evidence! Copyright 2003 Pearson Education Canada Inc.

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

The confirmation process must be controlled by the auditor. Copyright 2003 Pearson Education Canada Inc.

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Types of evidence - physical examination - confirmation - receipt of a written response from an independent third party at the auditor’s request Whenever reasonable, a sample of accounts receivable should be confirmed by the auditor. Copyright 2003 Pearson Education Canada Inc.

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

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What is the difference between internal and external documents?

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What is the difference between internal and external documents? External documents are usually on the client’s premises but were either prepared by a third party or processed by a third party (more persuasive). Copyright 2003 Pearson Education Canada Inc.

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What is the difference between internal and external documents?

Internal documents have been prepared by the client and have not left the client’s premises (less persuasive). Copyright 2003 Pearson Education Canada Inc.

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What is the primary determinant of the appropriateness of internal documents? Copyright 2003 Pearson Education Canada Inc.

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What is the primary determinant of the appropriateness of internal documents?

internal control Copyright 2003 Pearson Education Canada Inc.

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Types of evidence - physical examination - confirmation - documentation

What is the difference between physical examination and documentation? Copyright 2003 Pearson Education Canada Inc.

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What is the difference between physical examination and documentation? - physical examination - inspection or count by the auditor of a tangible asset

- documentation (vouching) - auditor examination of client documents and records Copyright 2003 Pearson Education Canada Inc.

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

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Types of evidence - physical examination - confirmation - documentation (vouching) - observation - inquiries of client - useful but biased and not persuasive unless supported by another form of evidence CPA Copyright 2003 Pearson Education Canada Inc.

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Types 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). Copyright 2003 Pearson Education Canada Inc.

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Types of evidence - physical examination - confirmation - documentation (vouching) - observation - inquiries of client - reperformance - analytical procedures - involve analysis of comparisons and interrelationships in data (may be performed by an audit software package). Copyright 2003 Pearson Education Canada Inc.

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Analytical procedures should be used during the planning and completion phases of the audit...

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Analytical procedures should be used during the planning and completion phases of the audit... but they may also be beneficial at other times during the audit. Copyright 2003 Pearson Education Canada Inc.

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Purposes of Analytical Procedures - facilitate understanding of client’s business and industry

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Purposes of Analytical Procedures - facilitate understanding of client’s business and industry - may indicate financial difficulty and the cliBert’s Boutique ent’s ability to continue as a going concern

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Purposes of Analytical Procedures - 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

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Purposes of Analytical Procedures - 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 Copyright 2003 Pearson Education Canada Inc.

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Types of Analytical Procedures - industry comparisons

How do the client’s financial ratios compare with those of the industry? Copyright 2003 Pearson Education Canada Inc.

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Types of Analytical Procedures - industry comparisons - comparisons with prior years

Ace Company

Ace Company

2003 financial statements

2004 financial statements

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Types of Analytical Procedures - industry comparisons - comparisons with prior years Ace Company

Ace Company

2003 financial statements

2004 financial statements

Conclusions from a 2-year analysis may be erroneous. WHY? Copyright 2003 Pearson Education Canada Inc.

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Types of Analytical Procedures - industry comparisons - comparisons with prior years - comparisons with client-determined expected results, e.g.,

budgets Copyright 2003 Pearson Education Canada Inc.

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Types of Analytical Procedures - industry comparisons - comparisons with prior years - comparisons with client-determined expected results - comparisons with auditor-determined expected results, examples: account sales commissions

can be calculated from ?????????????????

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Types of Analytical Procedures - industry comparisons - comparisons with prior years - comparisons with client-determined expected results - comparisons with auditor-determined expected results, examples: account sales commissions depreciation expense

can be calculated from sales ?????????????????? Copyright 2003 Pearson Education Canada Inc.

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Types of Analytical Procedures - 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 fixed assets interest expense ?????????????????? Copyright 2003 Pearson Education Canada Inc.

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Types of Analytical Procedures - 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 fixed assets interest expense notes/bonds payable Copyright 2003 Pearson Education Canada Inc.

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Types 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 from equipment maintenance expense ??????? 6 - 76 Copyright 2003 Pearson Education Canada Inc.

Types 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 from equipment maintenance expense production 6 - 77 Copyright 2003 Pearson Education Canada Inc.

Analytical procedures are often facilitated by audit software.

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If analytical procedures disclose unusual fluctuations or variances, the auditor should investigate by gathering additional evidence. Copyright 2003 Pearson Education Canada Inc.

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If analytical procedures disclose unusual fluctuations or variances, the auditor should investigate by gathering additional evidence.

The auditor should consider whether fluctuations or variances are material and whether they may be reasonably justifiable. Copyright 2003 Pearson Education Canada Inc.

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