Chapter 5: Evidence and Documentation

What is the relationship between audit evidence and the audit report?

Audit procedures provide evidence on the fairness of the financial statements, and the auditor reaches a conclusion based on that evidence.

What are management assertions?

Claims made by management about transactions, account balances, and disclosures in the financial statements.

What are assertions about classes of transactions and events?

Completeness, occurrence, authorization, accuracy, cutoff, classification, and presentation.

What are assertions about account balances?

Existence, rights and obligations, completeness, accuracy/valuation/allocation, classification, and presentation.

What is occurrence?

Recorded transactions and events actually occurred and pertain to the entity.

What is existence?

Assets, liabilities, and equity interests actually exist.

What is rights and obligations?

The entity has rights to assets, and liabilities are obligations of the entity.

What is completeness?

All transactions, events, assets, liabilities, equity interests, and required disclosures that should be recorded are recorded.

What is authorization?

Transactions and events have been properly authorized.

What is accuracy/valuation/allocation?

Amounts are recorded appropriately, and assets, liabilities, and equity are included at appropriate amounts.

What is cutoff?

Transactions and events are recorded in the correct accounting period.

What is classification?

Transactions, events, assets, liabilities, and equity are recorded in the proper accounts.

What is presentation?

Items are clearly described, properly aggregated or disaggregated, and understandable in the financial statements.

What is audit evidence?

The information used by the auditor to reach conclusions on which the audit opinion is based.

What are the three concepts of audit evidence?

1. Nature of audit evidence

2. Sufficiency and appropriateness of audit evidence

3. Evaluation of audit evidence.

What is the nature of audit evidence?

The form or type of information used as audit evidence.

What are examples of accounting records used as audit evidence?

• Initial entry records

• ledgers

• Journal entries

• worksheets

• spreadsheets

• reconciliations

• disclosures

• contracts

What are examples of other information used as audit evidence?

• Minutes of meetings

• Third-party confirmations

• Industry report

• Competitor data

• Control manuals

• Inquiry

• Observation

• Inspection

What is sufficiency of audit evidence?

The quantity of audit evidence.

How does risk affect sufficiency?

Greater risk of misstatement requires a higher quantity of audit evidence.

How does quality affect the amount of evidence needed?

Higher quality audit evidence means the auditor may need less evidence.

What is appropriateness of audit evidence?

The quality of audit evidence.

What two things make evidence appropriate?

Relevance and reliability.

What makes audit evidence more reliable?

• Independent outside sources

• effective internal controls

• auditor’s direct personal knowledge

• documentary evidence

• original documents

Which is more reliable:

Inquiry of an accounts receivable clerk regarding the accounts receivable balance – or – accounts receivable confirmations sent to a sample of customers

External confirmation is more reliable.

Which is more reliable:

Physical examination of lumber inventory performed by the external auditor – or – physical examination of inventory performed by internal auditors

Physical examination by the external auditor is more reliable.

What is needed to properly evaluate audit evidence?

Understanding the types of evidence available and the relative reliability of evidence.

How should an auditor evaluate evidence?

The auditor should be thorough in searching for evidence and unbiased in evaluation.

What are audit procedures?

Specific acts performed by the auditor to gather evidence about whether assertions are being met.

What are the three main types of audit procedures?

Risk assessment procedures, tests of controls, and substantive procedures.

What is an audit program?

A set of audit procedures prepared to test assertions for a component of the financial statements.

what are the audit assertions?

• completeness

• existence

• rights and obligations

• valuation

What procedure tests existence for accounts receivable?

Confirm accounts receivable.

What procedure tests rights and obligations for accounts receivable?

Inquire of management whether receivables have been sold.

What procedure tests completeness for accounts receivable?

Agree the accounts receivable subsidiary ledger to the accounts receivable control account.

What procedure tests valuation for accounts receivable?

Test the adequacy of the allowance for doubtful accounts.

What is inspection of records and documents?

Examining records or documents as audit evidence.

Are external or internal documents more reliable?

External documents are more reliable than internal documents.

What is observation?

Watching a process or procedure being performed by others.

What is inspection of tangible assets?

Physical examination of a tangible asset.

What is inquiry?

Asking questions of knowledgeable people inside or outside the entity.

What should an auditor do when using inquiry?

Ask clear questions, listen effectively, follow up, and evaluate responses.

What is confirmation?

Audit evidence obtained as a direct written response from a third party.

What are common items confirmed by auditors?

• Cash

• accounts receivable

• inventory on consignment

• accounts payable

• bonds payable

• shares outstanding

• insurance coverage

• loan collateral

What is recalculation?

Checking the mathematical accuracy of documents or records.

What is reperformance?

The auditor independently performs procedures or controls originally performed by company personnel.

What is scanning?

Judgmentally reviewing accounting data to identify significant or unusual items to test.

What are analytical procedures?

Evaluations of financial information by studying plausible relationships among financial and nonfinancial data.

What is tracing?

Using source documentation to see if a transaction has been recorded in the accounting system.

What assertion does tracing usually test?

Completeness.

What is vouching?

Starting from accounting records and checking source documents.

What assertion does vouching usually test?

Occurrence.

What types of Audit evidence are generally most reliable?

Inspection of tangible assets, reperformance, and recalculation.

What types of audit evidence are generally moderately reliable?

Inspection of records and documents, confirmation, analytical procedures, and scanning.

What Audit types of evidence are generally least reliable?

Observation and inquiry.

What is audit documentation?

The auditor’s record of procedures performed, evidence obtained, and conclusions reached.

What are working papers?

Another name for audit documentation.

What are the three functions of audit documentation?

1. Support the audit report

2. aid planning/performance/supervision

3. provide a basis for review and quality reviews

What should audit documentation demonstrate?

That the audit complied with standards and supports the auditor’s conclusions for material assertions.

What should audit documentation show about accounting records?

That underlying accounting records agreed or reconciled with the financial statements.

What should audit documentation include?

A written audit program with procedures needed to accomplish audit objectives.

What should a knowledgeable reviewer be able to understand from audit documentation?

The nature, timing, extent, and results of procedures, evidence obtained, and conclusions reached.

What should documentation show about who did the work?

Who performed and reviewed the work, plus the dates of work and review.

What are the two types of audit documentation files?

Permanent files and current files.

What is included in a permanent file?

Items useful for more than one audit, such as:

• corporate charter

• contracts

• chart of accounts

• Internal control documentation

• organization chart.

What is included in a current file?

Items for the current audit, such as:

• audit plan

• programs

• working trial balance

• current financial statements

• adjusting entries

• supporting working papers

What should the heading of audit documentation include?

Entity name, title of working paper, and entity’s year-end date.

What are indexing and cross-referencing?

Notations that provide a trail from financial statements to audit documents.

What are tick marks?

Notations showing auditor or reviewer actions.

Who owns audit documentation?

The auditor owns the audit documentation, including documents prepared by the entity at the auditor’s request.

Why must audit documentation be organized?

So audit team members and others can find evidence supporting financial statement accounts.

What are analytical procedures used for?

Risk assessment, substantive testing, and final overall review.

What are risk assessment analytical procedures used for?

To understand the business and plan the nature, timing, and extent of audit procedures.

What are substantive analytical procedures used for?

To obtain evidence about particular assertions related to account balances or classes of transactions.

What are final analytical procedures used for?

As an overall review of financial information in the final review stage of the audit.

What is the primary objective of final analytical procedures?

To assist the auditor in assessing the validity of the conclusions reached on the audit.

What are the three types of analytical procedures?

Trend analysis, ratio analysis, and reasonableness analysis.

What is required when analytical procedures are used?

The auditor must have an expectation.

What sources can be used to develop an expectation?

• Financial and operating data

• budgets

• forecasts

• competitor information

• management analyses

What is precision?

The quality of an expectation and how closely it approximates the correct but unknown amount.

When does an expectation need to be more precise?

When the assertion requires a low level of detection risk.

What happens when an expectation is more precise?

Audit procedures become more extensive and expensive.

What four factors affect the precision of analytical procedures?

1. Disaggregation

2. plausibility/predictability

3. Data reliability

4. Type of analytical procedure used.

What is tolerable difference?

The amount of difference between the expectation and recorded amount that the auditor can accept without further investigation.

What does tolerable difference usually equal?

The account’s tolerable misstatement.

What happens if the difference is greater than the tolerable difference?

The auditor investigates the difference.

What must explanations for significant differences be followed up with?

Quantification, corroboration, and evaluation.

What is quantification?

Determining whether the explanation or error can explain the observed difference

What is corroboration?

Obtaining sufficient appropriate evidence linking the explanation to the difference.

What is evaluation?

Concluding whether the desired level of assurance has been achieved.

Do risk assessment analytical procedures require corroborating evidence?

No, corroborating evidence is not required

Do final analytical procedures require corroborating evidence?

Yes, corroborating evidence is required.

The primary objective of final analytical procedures is to:

A.Obtain evidence from details tested to corroborate particular assertions

B.Identify areas that represent specific risks relevant to the audit

C.Assist the auditor in assessing the validity of the conclusions reached on the audit

D.Satisfy doubts when questions arise about an entity’s ability to continue in existence

C.Assist the auditor in assessing the validity of the conclusions reached on the audit

What do short-term liquidity ratios indicate?

The entity’s ability to meet current obligations.

What are examples of short-term liquidity ratios?

Current ratio, quick ratio, and operating cash flow ratio.

What do activity ratios indicate?

How effectively the entity’s assets are managed.

What are examples of activity ratios?

Receivables turnover, days outstanding in accounts receivable, inventory turnover, and days of inventory on hand.

What do profitability ratios indicate?

The entity’s success or failure for a given period.

What are examples of profitability ratios?

Gross profit percentage, profit margin, return on assets, and return on equity.

What do coverage ratios indicate?

The long-term solvency of the entity.