CHAPTER 6 Audit Evidence

Learning Check
6-1. a. Audit evidence is all the information used by the auditor in arriving at the conclusion on which the audit opinion is based. Audit evidence includes (1) the accounting records underlying the financial statements and (2) other information that corroborates the accounting records and supports the auditors logical reasoning about fair presentation in the financial statements. Any information that is obtained by the auditor to arrive at conclusions on which the audit is based is audit evidence. nformation obtained while performing ris! assessment procedures supports many important audit conclusions. "ence# this is important audit evidence and needs to have the traits of sufficient# competent evidence. n many cases the auditor uses !nowledge and information from the prior year to ma!e preliminary ris! assessments. "owever# the auditor usually updates those conclusions with additional evidence from the current year. Accounting records generally include the records of initial entries and supporting records. $or e%ample accounting records would include& 'hec!s and records of electronic funds transfers# nvoices# 'ontracts# (he general and subsidiary ledgers# )ournal entries# and other ad*ustments to the financial statement that are not reflected in formal *ournal entries# +ecords such as wor!sheets and spreadsheets supporting cost allocations# computations# and reconciliations# and ,isclosures. -%ample# accounting records associated with the sales and collections cycle might include& c. .ales orders /ills of lading and other shipping documents .ales invoices (he sales *ournal A remittance advice A prelisting of cash receipts ,eposit slips (he cash receipts *ournal

b.

6-2.

a.

b.

Accounting records alone do not provide sufficient evidence on which to base an audit opinion on the financial statements. (he auditor must corroborate information in the

accounting records with other sources of evidence such as confirmation from third parties# the auditors own observation# tests of controls# and information obtained through other audit procedures. 6-0. a. 1ther information includes evidence such as& b. 2inutes of meetings# 'onfirmation from third parties# Analysts reports# 'omparable data about competitors (benchmar!ing)# nternal control manuals# nformation obtained through audit procedures such as in3uiry# observation or inspection of records or documents# and nformation developed by the auditor that permits the auditor to reach a conclusion through valid logical reasoning. 'onfirmation of third parties. n3uiry and observation about internal controls. nspection of documents that have been validated e%ternally such as a bill of lading# a remittance advice# or a deposit slip. nspection of collection history for slow paying clients. /an! statements. All fi%ed assets e%ist and recorded fi%ed asset transactions actually occurred during the accounting period. All fi%ed assets (including capital leases) are recorded. (he entity has rights to recorded fi%ed assets and the obligations associated with fi%ed assets are the obligations of the entity. $i%ed assets are properly valued in the financial statements. nformation about fi%ed assets is properly presented and disclosed in the financial statements. Occurrence. $i%ed asset transactions and events that have been recorded have occurred and pertain to the entity. $or e%ample# additions to fi%ed assets during the period actually occurred and pertain the entity and items that were capitali5ed should have been capitali5ed. Completeness. All fi%ed asset transactions and events that should have been recorded# are recorded. $or e%ample# all fi%ed assets that were ac3uired during the period were recorded in the accounting records. tems that should have been capitali5ed were not directly e%pensed during the period.

1ther information that is relevant to the sales and collections cycle might include&

6-4.

a.

(he five assertions for fi%ed assets can be stated as follows&

b.

(he transaction class audit ob*ectives for fi%ed assets can be stated as follows&

Accuracy. Amounts and other data related to recorded fi%ed asset transactions and events have been recorded accurately. $or e%ample# all fi%ed assets that were recorded during the period were accurately recorded at the proper dollar amounts. Cutoff. $i%ed asset transactions and events have been recorded in the correct accounting period. $or e%ample# all additions to fi%ed assets were recorded in the correct accounting period. Classification. $i%ed asset transactions and events have been recorded in the proper accounts. $or e%ample# ac3uired assets were properly classified as land# buildings# e3uipment# or capital leases. Existence. +ecorded fi%ed assets actually e%ist. $or e%ample# e3uipment recorded in the accounting records actually are for long-lived assets in place. Completeness. All fi%ed assets that should have been recorded# are recorded. $or e%ample# all fi%ed assets owned by the company are recorded. Rights and Obligations. (he entity holds or controls rights to fi%ed assets# and liabilities are the obligations of the entity. $or e%ample# the entity actually holds rights to fi%ed assets and capital leases and capital leases are the obligations of the entity. Valuation and Allocation. $i%ed assets are included in the financial statements at the appropriate amounts and any appropriate valuation ad*ustments are appropriately recorded. $or e%ample# fi%ed assets are properly valued net of accumulated depreciation and any fi%ed asset impairments have been recorded. Occurrence and Rights and Obligations. ,isclosed fi%ed asset events and transactions have occurred and pertain to the entity. $or e%ample# disclosures regarding fi%ed assets represented purchases and sales that actually occurred and the company has rights do fi%ed assets included in disclosures. Completeness. All fi%ed asset disclosures that should have been included in the financial statements have been included. $or e%ample# all fi%ed asset disclosures re3uired by 6AA7 are included in the financial statements. Classification and Understandability. $i%ed asset information is appropriately presented and information in disclosures is clearly e%pressed. $or e%ample# the footnote related to fi%ed assets is appropriately presented and clearly e%pressed. Accuracy and Valuation. $i%ed asset information is disclosed accurately and at appropriate amounts. $or e%ample# footnote disclosures accurately include amounts and values related to depreciation e%pense and any impairment of fi%ed asset values.

c.

Account balance audit ob*ectives for fi%ed assets can be stated as follows&

d.

,isclosure audit ob*ectives for fi%ed assets can be stated as follows&

6-8.

$actors that may affect the auditors *udgment as to sufficiency of evidence include& 2ateriality 9 n general# more evidence is necessary for transaction classes# accounts and disclosures that are material to the financial statements than for those that are immaterial.

 6-6.

+is! of 2aterial 2isstatement 9 n general# more evidence will be necessary for assertions that have higher inherent ris! and :or control ris!. .i5e and characteristics of the population 9 n general# a more homogeneous population will allow for a smaller sample si5e.

+elevance means that evidence must be pertinent to managements assertions in the financial statements. (hus# if the auditor is e%amining the e%istence of fi%ed asset# the auditor can obtain evidence by observing fi%ed assets in place. "owever# such evidence might not be relevant in determining whether the assets goods are owned by the entity (rights and obligations). -vidence related to one assertion is not a substitute for obtaining audit evidence regarding another assertion. a. (he si% factors that influence the reliability of evidence are& b. (he independence of the source of evidence <hether the evidence is obtained directly by the auditor (he operating effectiveness of internal controls related to an assertion (he nature of written documents# such as whether they are se3uentially numbered or contain contemporaneous written notes that are relevant to an assertion <hether documents are originals or copies -vidence from different sources is consistent with each other.

6.;

$ollowing is a series of e%amples related to the recording of sales that illustrate each of the si% factors described in a) above. (he independence of the source of evidence. $or e%ample# information obtained from confirmations is independent of the audit client. <hether the evidence is obtained directly by the auditor. $or e%ample# confirmations should be received directly by the auditor from the customer. (he operating effectiveness of internal controls related to an assertion. $or e%ample# information obtained from the accounting system is more reliable when it comes from a system of internal control that operates effectively. (he nature of written documents# such as whether they are se3uentially numbered or contain contemporaneous written notes that are relevant to an assertion. $or e%ample# written e%planations of manual follow-up of item s that appear on e%ception reports add credibility to the document. An e%ception report with no written notes would not have the same degree of reliability. <hether documents are originals or copies. $or e%ample# original bills of lading are more reliability than photocopies of bills of lading. -vidence from different sources is consistent with each other. $or e%ample# sales invoice information is more reliable when it is consistent with customer confirmations.

6-=.

a.

,ocuments that are e%ternally generated are more reliable than internally generated documents. n addition# documents (such as cancelled chec!s) that are created internally# but are circulated e%ternally and returned with notations by the client# are more reliable that other internal documents that do not circulate outside the entity. n the conte%t of sales and accounts receivable a confirmation from a customer would be considered a very reliable document. A sales invoice# which is internally created# would not be considered reliable by itself. t would need corroborating evidence.

b.

6->.

(he following table identifies nine types of audit procedures and provides an e%ample of each. Audit 7rocedure nspection of documents and records nspection of tangible assets 1bservation n3uiry 'onfirmation +ecalculation +eperformance Analytical procedures 'omputer assisted audit techni3ues -%ample nspecting bills of lading# sales orders and sales invoices nspecting inventory during shipment or counting cash 1bservation of inventory being shipped or observation of people performing internal controls 2a!ing in3uiries of personnel responsible for approving credit about past due accounts 1btaining a confirmation from a customer about amounts owed to the audit client +ecalculating amounts on a sales invoice +eperforming an internal control procedure 'alculating and analy5ing accounts receivable turn days (otaling the detail of the accounts receivable subsidiary ledger and comparing the total to the general ledger or selecting accounts for confirmation.

6-1?.

n vouching# the direction of testing is from the accounting records to the documents. @ouching pertains to the e%istence or occurrence assertion. n tracing# the direction of testing is from documents to the accounting records. (racing pertains to the completeness assertion. .taffing decisions are about who on the audit team will initially collect and evaluate evidence. $or e%ample# the auditor might assign someone with two or three years of audit e%perience to evaluate the ade3uacy of an allowance for doubtful accounts. An audit team might use an new audit staff member to audit routine transactions such as auditing the results of confirmation when revenue recognition is straight forward. (he audit team will usually assign more e%perienced individuals to assertions that have a high degree of sub*ectivity or comple%ity. (he auditor will consider the ris! of material misstatement when ma!ing decisions about audit staffing. <hen accounting records and corroborating evidence are available only in electronic form the audit team should include a computer audit specialist who is capable of

6-11. a. b.

c.

d.

addressing the comple%ity of internal controls over records that are available only in electronic form. 6-12. a. b. ,ecisions about the nature of evidence are about the choice of type of audit procedure to perform. $or e%ample# an auditor could send a confirmation about the e%istence of accounts receivable. Alternatively# the auditor could validate the e%istence of an accounts receivable by loo!ing at subse3uent cash receipts and by loo!ing that the documents that support shipment before month end. (he auditor will usually consider the ris! of material misstatement when ma!ing decisions about audit procedures. (he auditor also needs to consider the types of evidence that may be available when ma!ing decisions about audit procedures. <hen accounting records and corroborating evidence are available only in electronic form the audit team may have to modify the procedures to understand the system# tests controls and perform substantive test. (he auditor may use computer assisted audit techni3ue to perform both tests of controls and substantive tests. ,ecision about the timing of audit procedures are about whether to perform tests as of an interim date or as of year-end. $or e%ample# the auditor might modify the timing of tests by sending confirmations of accounts receivable balances as of a date one or two months prior to year-end. (he auditor might consider performing substantive tests at an interim date if internal controls are strong and if the ris! of material misstatement is low. <hen accounting records and corroborating evidence are available only in electronic form the audit team might consider modifying the timing of tests to observe documents during the short time that they are present before they are copied into a digital imaging system. ,ecisions about the e%tent of audit procedures are decisions about sample si5e. $or e%ample# the auditor might choose between confirming >8A of dollar amount of accounts receivable or send fewer confirmations and confirm only 6?A of the dollar amount of accounts receivable. (he audit team will normally use larger sample si5es for assertions with a high ris! of material misstatement. f information about the assertion that the auditor wants to test is available in electronic form the auditor can use computer assisted audit techni3ues to select audit samples.

c.

d.

6-10. a. b. c. d.

6-14. a. b.

c. d.

6-18. <or!ing papers may be defined as the records !ept by the auditor of procedures applied# the tests performed# the information obtained# and the pertinent conclusions reached in the audit. <or!ing papers provide the principal support for the auditorBs report# evidence that the audit was made in accordance with 6AA.# and a means for coordinating and supervising the audit. 6-16. $our ma*or types of wor!ing papers are (a) wor!ing trial balance# (b) schedules and analyses# (c) audit memoranda and documentation of corroborating information# and (d) ad*usting and reclassifying entries. 6-1. $ive essential techni3ues of good wor!ing paper documentation are&

1. "eading. -ach wor!ing paper should contain the name of the client# a descriptive title identifying the content of the wor!ing paper# such as /an! +econciliation---'ity Cational /an!# and the balance sheet date or the period covered by the audit. 2. nde% Cumber. -ach wor!ing paper is given an inde% or reference number# such as A-1# /-2# and so forth# for identification and filing purposes.

0. 'ross-referencing. ,ata on a wor!ing paper that is ta!en from another wor!ing paper or that is carried forward to another wor!ing paper should be cross-referenced with the inde% numbers of those wor!ing papers. 4. (ic! 2ar!s. (ic! mar!s are symbols# such as chec! mar!s# that are used on wor!ing papers to indicate that the auditor has performed some procedure on the item to which the tic! mar! is affi%ed# or that additional information about the item is available elsewhere on the wor!ing paper. A legend on the wor!ing paper should e%plain the nature and e%tent of the wor! represented by each tic! mar! or provide the additional information applicable to the items so mar!ed. 8. .ignature and dates. Dpon completing their respective tas!s# both the preparer and reviewer of a wor!ing paper should initial and date it. (his establishes responsibility for the wor! performed and the review. 6-1=. (wo categories of wor!ing paper files are (1) the current file and (2) the permanent file. (he current file contains corroborating information pertaining to the e%ecution of the current yearBs audit program. (he permanent file typically includes such items as& 6-1>. 'opies of the articles of incorporation and bylaws. 'hart of accounts and procedure manuals. 1rgani5ation charts. 7lant layout# manufacturing processes# and principal products. (erms of capital stoc! and bond issues. 'opies of long-term contracts# such as leases# pension plans# and profit-sharing and bonus agreements. .chedules for amorti5ation of long-term debt and depreciation of plant assets. .ummary of accounting principles used by the client. a. <or!ing papers belong to the auditor who is responsible for their custody and safe!eeping. b. (he A '7ABs 'ode of 7rofessional 'onduct stipulates that a '7A shall not disclose any confidential information obtained during the course of a professional engagement without the consent of the client# e%cept for certain circumstances as stated in the rule. (he latter include disclosing the contents of wor!ing papers in order to comply with a validly issued and enforceable subpoena or summons or applicable law or government regulation# ma!ing the wor!ing papers available for a 3uality or peer review under A '7A# state '7A society# or /oard of Accountancy authori5ation# or in responding to any in3uiry made by the 7rofessional -thics ,ivision or (rial /oard of the A '7A or a

duly constituted investigative or disciplinary body of a state '7A society or /oard of Accountancy