Audit Evidence and Documentation

1
Audit Evidence and Documentation
Chapter 5
2
Management Assertions

• Existence or Occurrence
• Completeness
• Rights and Obligations
• Valuation or Allocation
• Presentation and Disclosure

3
Management Assertions

• Existence or Occurrence--Assets, liabilities, and
  owners equity accounts reflected in the
  financial statements exist the recorded
  transactions have occurred.
• Completeness--All transactions, assets,
  liabilities, and elements of owners equity that
  should be presented in the financial statements
  are included.
• Rights and Obligations--The client has rights to
  assets and obligations to pay liabilities that
  are included in the financial statements.
• Valuation or Allocation--Assets, liabilities,
  owners equity, revenues, and expenses are
  presented at amounts that are determined in
  accordance with generally accepted accounting
  principles.
• Presentation and Disclosure--Accounts are
  described and classified in the financial
  statements in accordance with generally accepted
  accounting principles, and all material
  disclosures are provided.

4
Risk Definitions

• Inherent Risk
• Control Risk
• Detection Risk

5
Inherent Risk Considerations

• Segregate transactions
• Routine
• Non-routine
• Estimation

6
Audit Risk

• Risk of
  Material Risk That the
• Audit Risk Misstatement
  Auditors Fail to detect
• 
  the Misstatement
• Inherent
  Control Detection
• Risk
  Risk Risk

7
Audit Risk Formula
AR IR CR DR AR
Audit risk IR Inherent risk CR Control
risk DR Detection risk
8
Audit Risk Formula
AR IR CR DR Often
expressed as DR AR/ (IR CR) AR
Audit risk IR Inherent risk CR
Control risk DR Detection risk
9
Audit Risk Model - Illustrations

• Company A has many complex transactions and weak
  internal controls.
• Audit Risk (AR) has been set by the firm at 5.
• Calculate the Detection Risk (DR) of this
  engagement

• Company B has simple transactions, effective
  internal controls and well-trained staff.
• Audit Risk (AR) has been set by the firm at 5.
• Calculate the Detection Risk (DR) of this
  engagement

10
Competence of Evidential Matter

• To be competent evidence must be
• Valid
• Relevant

11
Competence of Evidential Matter

• Principles
• Independent sources vs. from within the client
  organization
• Strong internal control vs. weak internal control
• Directly obtained evidence vs. second hand.

12
Reliability of Certain Types of Audit Evidence
RELIABILITY TYPE EXAMPLE High Physical Invento
ry Observation Documentary External Cutoff
Bank Statement External/Internal Purchase
Invoice Internal Sales Invoice Low Client
Representations Management Representation
Letter
13
Types of Evidence

• Accounting information system
• Documentary evidence
• Third-party representations
• Physical evidence
• Computations
• Data interrelationships
• Client representations

14
Types of Evidence and Audit Procedures

• Accounting information system
• Documentary evidence
• Third-party representations
• Client representations
• Physical evidence
• Computations
• Data interrelationships

• Observation
• Physical examination
• Inquiry internal
• Inquiry external
• Examination of docs
• Recomputation
• Reprocessing
• Vouching
• Analytical procedures

15
Audit Procedures

• Observation
• Physical examination
• Inquiry internal
• Inquiry external
• Examination of docs
• Recomputation
• Reprocessing
• Vouching
• Analytical procedures

16
Nature of testing
17
Develop Expectations

• The auditor should develop expectations that are
  independent of management and are objectively
  based on a thorough analysis of the company and
  its operations.

18
Using Analytical Tools to Develop Expectations

• Assumptions underlying analytical techniques
• Plausible relationships among data may reasonably
  be expected to exist and continue in the absence
  of known conditions to the contrary.
• Examples
• Relationships between certain accounts
• Consistent nature of entitys business cycle
• Budget to actual comparisons
• Reasonableness tests

19
Analytical Techniques

• Trend analysis
• Ratio analysis
• Comparison of client data with industry data
• Comparison of client data with similar
  prior-period data
• Comparison of client data with expectations
• Regression analysis

20
Trend Analysis
21
Ratio Analysis

• Effective interest rateInterest expense/average
  debt o/sTarget 5.8
• Implied life of fixed assetsAverage depreciable
  fixed assets/ depreciation expenseTarget 12.6
  years

22
Common Ratio Analysis
23
Basic Approaches to Auditing Accounting Estimates

• Review and test managements process for
  developing the estimate.
• Independently develop an estimate to compare to
  managements estimate.
• Review subsequent events or transactions bearing
  on the estimate.

24
Auditing Fair Values

• If traded on an organized market, obtain from
  market prices
• If item does not trade on an organized market
• Analyzing to a similar market if possible
• Using a valuation model

25
Sufficiency of Audit Documentation

• Audit documentation should be sufficient to
  enable members of the audit team
• To understand who performed and reviewed the work
• To understand what work was performed
• To show that the accounting agree or reconcile to
  the financial statements

26
Functions of Working Papers

• Provide a means of assigning and coordinating
  audit work
• Aid in supervising and reviewing the audit work
• Provide support for the auditors opinion
• Document the auditors compliance with generally
  accepted auditing standards, especially the
  standards of field work
• Aid in planning and conducting future audits

27
Types of Working Papers

• Audit administrative working papers
• Working trial balance
• Lead schedules
• Adjusting journal entries and reclassification
  entries
• Supporting schedules
• Analysis of a ledger account
• Reconciliations
• Computational working papers
• Corroborating documents

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Types of Working Files

• Current files
• Permanent files