auditing chapter 6
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AUDITING CHAPTER 6. Evidence By David N. Ricchiute. TOPICS. Acquisition & evaluation of evidence Financial statement assertions, audit objectives, & audit procedures Tests of controls, substantive tests, analytical procedures & nonfinancial measures Audit documentation. AUDIT EVIDENCE. - PowerPoint PPT PresentationTRANSCRIPT
AUDITINGCHAPTER 6EvidenceByDavid N. Ricchiute
GBW 8th ed., Ch. 62
TOPICSAcquisition & evaluation of evidenceFinancial statement assertions, audit objectives, & audit proceduresTests of controls, substantive tests, analytical procedures & nonfinancial measuresAudit documentation
GBW 8th ed., Ch. 63
AUDIT EVIDENCESufficient competent evidential matter
is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding financial statements under audit.
SAS 31 & SAS 80, Amendment to SAS 31.
GBW 8th ed., Ch. 64
MEANING OF SUFFICIENT, COMPETENT EVIDENCE
Sufficient: quantity of evident necessary to test management’s assertionsCompetent: relevant, valid, reliable Kinds of evidence necessary to test
management’s assertionsLink audit risk & audit evidence Relevance Amount of evidence
GBW 8th ed., Ch. 65
EVIDENTIAL MATTERUnderlying accounting data Records of original entry (journals, ledgers,
etc.) Data files SpreadsheetsCorroborating information Documents (checks, invoices, contracts) Written representations from 3rd parties
(vendors, attorneys) Inquiries of management
GBW 8th ed., Ch. 66
FINANCIAL STATEMENT ASSERTIONS
Existence or OccurrenceCompletenessRights & ObligationsValuation or AllocationPresentation & Disclosure
GBW 8th ed., Ch. 67
ACCOUNTS & JOURNAL ENTRIES
Purchase & sale of inventoryInventory Accounts payable
Cost of Goods Sold Inventory
GBW 8th ed., Ch. 68
EXISTENCE OR OCCURRENCE ASSERTION
All assets, liabilities, equities existAll transactions occurredExample Test whether inventory physically
existed at balance sheet date
GBW 8th ed., Ch. 69
COMPLETENESS ASSERTION
All transactions that occurred during period are reported for the time periodAll accounts complete as to dataExamples Test whether all purchases goods,
services are recorded Test whether all obligations included as
liabilities
GBW 8th ed., Ch. 610
RIGHTS & OBLIGATIONS ASSERTION
Entity entitled to assets (rights)Entity liable for obligations Example Test whether all inventory is
owned, not on consignment
GBW 8th ed., Ch. 611
VALUATION OR ALLOCATION ASSERTION
Assets, liabilities, equities, revenues, expenses recorded at proper amountsExample Test whether inventory valued at
lower cost/market Revenues, costs, expenses allocated to proper accounting periods
GBW 8th ed., Ch. 612
PRESENTATION & DISCLOSURE ASSERTION
Financial statement components properly classified, described & disclosedExample Test to assure financial
statements, notes reveal substance of recorded transactions
GBW 8th ed., Ch. 613
AUDIT PROCEDURESObservationDocumentationConfirmationMechanical testsAnalytical procedures (Comparisons)Inquiries
GBW 8th ed., Ch. 614
RELATING OBJECTIVES TO OBSERVATION
Direct evidence about existence Example:
physically observing client’s assets
GBW 8th ed., Ch. 615
RELATING OBJECTIVES TO DOCUMENTATION
Internal evidence in documentary form to support existence, valuation Example: vouch
documents supporting selected cash disbursements or liabilities
GBW 8th ed., Ch. 616
RELATING OBJECTIVES TO CONFIRMATION
External evidence from third parties supporting existence, valuation of account balances Example: request
confirmation of accounts receivable
GBW 8th ed., Ch. 617
RELATING OBJECTIVES TO MECHANICAL TESTS
Direct evidence to support valuation Example: recomputing
(footing) cash receipts journalDirect evidence to support presentation Example: trace transactions
through accounting system for proper recording, classification
GBW 8th ed., Ch. 618
RELATING OBJECTIVES TO COMPARISONS
Analytical procedures (Comparisons) Direct evidence about
completeness, presentation, disclosure
Example: examine trends for advertising expense to determine whether more procedures necessary
Example: compare disclosures with prior periods
GBW 8th ed., Ch. 619
RELATING OBJECTIVES TO INQUIRIES
Direct evidence although less persuasive, may help generate leads Corroborated
through other procedures
GBW 8th ed., Ch. 620
TESTS OF CONTROLS & SUBSTANTIVE TESTS
Tests of controls Audit procedures to assess the ability
of controls to prevent or detect material misstatements
Provide evidence about control riskSubstantive tests Audit procedures that detect material
misstatements Provide evidence about detection risk
GBW 8th ed., Ch. 621
TESTS OF CONTROLS
Procedures address questions such as How are controls applied? Are controls applied consistently? By whom are controls applied?
GBW 8th ed., Ch. 622
TESTS OF CONTROLS & CONTROL RISK
Tests of controls are procedures to assess control riskAssessed level control risk helps determine acceptable level detection risk
GBW 8th ed., Ch. 623
CATEGORIES OF CONTROL ACTIVITIES
Controls that create documentation, i.e., leave an audit trail Manager’s initials for credit approval Prevention control
Controls that do not create documentation Bank reconciliation provides no evidence of
independence of preparer for cash function Detection control
GBW 8th ed., Ch. 624
COMBINED SUBSTANTIVE & CONTROL TESTSDual-purpose tests
Provide evidence about control risk & monetary error
Example: recomputing extensions on sales invoices
GBW 8th ed., Ch. 625
SUBSTANTIVE TESTS
Tests of details Transactions BalancesAnalytical tests
GBW 8th ed., Ch. 626
ANALYTICAL PROCEDURES
Evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data
SAS No. 56
GBW 8th ed., Ch. 627
TESTS OF DETAILS v. ANALYTICAL TESTS
Comparisons Tests of details tests all 5 assertions
but analytical procedures do not support existence or rights & obligations Analytical procedures are high level tests
Tests of details lead to conclusions about aggregated data but analytical procedures test aggregated data
GBW 8th ed., Ch. 628
USING ANALYTICAL PROCEDURESWhen Purpose
Planning (required) Directs attention to likely misstatements
Substantive tests Supports or refutes account balances
Overall review (required)
Reviews reasonableness account balances
GBW 8th ed., Ch. 629
TYPES ANALYTICAL PROCEDURES
Trend analysisRatio analysis Activity ratios Profitability ratios Liquidity ratios Solvency ratiosModeling Statistical tests, i.e., regression
GBW 8th ed., Ch. 630
JUDGMENT ERRORS & ANALYTICAL PROCEDURES
Over reliance on unaudited numbersDisregard for unchanging account balancesOverreliance on management’s explanations
GBW 8th ed., Ch. 631
CUSTOMER PERSPECTIVE & SKEPTICISMIssue Professional skepticismTime Declining on-time
delivery ratesQuality
Performance
Increasing customer complaintsIncreasing customer complaints
Cost Failure to be low-cost provider
GBW 8th ed., Ch. 632
INTERNAL BUSINESS & SKEPTICISM
Issue Professional skepticismDevelopment Failure to be first to market
Quality Increasing defect rates
Productivity Unfavorable price, quantity variances
Core competencies
Employees fail certification exams
GBW 8th ed., Ch. 633
INTERNAL LEARNING & SKEPTICISMIssue Professional
Skepticism Improved performance
Poor performance against industry best practices
Innovation Lagging product development
GBW 8th ed., Ch. 634
COGNITIVE BIASES IN EVALUATING EVIDENCE
Heuristics: simplifying rules of thumb that may bias decision making Representativeness Availability Anchoring-and-adjustment
GBW 8th ed., Ch. 635
COGNITIVE BIASES:Representativeness
Given an item, b, and a class of items, A, making a judgment based on how much b resembles other items from class A rather than making a judgment based on the probability that b came from class A.
GBW 8th ed., Ch. 636
COGNITIVE BIASES:AvailabilityThe decision maker evaluates the
likelihood of a particular outcome based on infrequent but highly publicized outcomes rather than outcomes predicted by the profession’s collected experience.
GBW 8th ed., Ch. 637
COGNITIVE BIASES:Anchoring-and-Adjustment
The decision maker assesses likelihood of an outcome with an initial, sometimes biased probability estimate (anchor) then adjusts the probability insufficiently when discovering new information.
GBW 8th ed., Ch. 638
AUDIT DOCUMENTATIONASB Standards
Auditor’s judgment about nature, extent of documentation depends on Risk of misstatement Judgment about audit work Nature of procedures Significance of evidence Nature, extent of assertions tested
GBW 8th ed., Ch. 639
AUDIT DOCUMENTATIONPCAOB
Reviewability standard Derived from governmental standards Documents sufficient for experienced
auditor to understand work performed, when, why
Rebuttable presumption Absent documentation of audit work,
presumption that work not performed
GBW 8th ed., Ch. 640
AUDIT DOCUMENTATION FILES
Correspondence (administrative) filePermanent file Information of continuing interest &
relevanceTax file Past, present, future income &
property tax obligations
GBW 8th ed., Ch. 641
ROLE OF AUDIT DOCUMENTATION
Work was adequately planned, supervised, and reviewed (1st standard fieldwork)Internal control considered as basis for substantive tests (2nd standard fieldwork)Sufficient competent evidential matter was obtained (3rd standard fieldwork)
GBW 8th ed., Ch. 642
AUTOMATED DOCUMENTATION
Spreadsheet software Analytical procedures, data
import/export, graphing, sortingDatabase management Relational structuring: combining
2 or more files for single queryText retrieval Access & retrieve electronically
stored text