AUDITING 3 (Module 1)

Obtaining Audit evidence chapter 5

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INTRODUCTION

EVIDENCE
Audit evidence is absolutely crucial to the audit function to Support opinion. ISA 500 - "The Auditor should obtain : SUFFICIENT APPROPRIATE EVIDENCE to be able to draw a reasonable conclusions on which to base audit opinion." : KEY PHRASE = sufficient appropriate evidence. Evidence usually relates to Assertions on Fin Stats.

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SUFFICIENT APPROPRIATE EVIDENCE

Overall measure of whether enough sufficient appropriate evidence is gathered cannot be 100% exactly determined: BUT SUFFICIENT EVIDENCE: 1) SUFFICIENT means if QUANTITY of evidence is enough.
2) Evidence is Cumulative:

E.g. debtors test = 1-debtors circularisation + 2-test if debtors pay (very good evidence they exist!)

3) To calc. quantity of evidence needed

=NO hard and fast way, only: USE professional Judgment + statistical methods. This is done as part of the "AUDIT PLAN" stage.

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SUFFICIENT APPROPRIATE EVIDENCE

1) APPROPRIATE Means if QUALITY of evidence is enough. Further broken down into: a)RELIABILITY (source & nature) b)RELEVANCE (to assertion being tested)

2) RELIABILITY: Hierarchy of Reliability of Evidence: a) Most Reliable =Developed by auditor: e.g. (inspect stock) b) Reasonably Reliable =Evidence from 3rd party (not client) if 1-Independant 2-Reputable 3-Competent e.g. (attorney)

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SUFFICIENT APPROPRIATE EVIDENCE

Less Reliable =From 3rd party BUT passed through client.

E.g.: bank statement.

Less Reliable =Evidence from clients SYSTEM and where related controls it passed through were Effective Least reliable= Evidence provided by client (lacks independence) Written more reliable than oral (easy denied) Original documents More than Photocopies/facsimiles. Also, REM these are guidelines, e.g. if competence + integrity of directors employees are strong & acc.sys and internal controls are strong, evidence from client could be very reliable. E.g. sheet to shelf = existence BUT shelf to sheet =completeness.

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SUFFICIENT APPROPRIATE EVIDENCE

3) RELEVANCE: a)Evidence MUST be MATCHED to assertion tested : e.g.; self stock count= 'existence some 'valuation' BUT not 'rights' e.g. could be uncollected but sold .NOR 'completeness' yet e.g. must first be traced to records to determine if all were included in records. b)E.g. tests of controls as to accuracy will not prove validity or completeness. c)A single procedure could be relevant to more than 1 assertion though.

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SUFFICIENT APPROPRIATE EVIDENCE

INFLUENCEING FACTORS IN DETERMINING WHETHER SUFFICIENT APPROPRIATEEVIDENCE HAS BEEN OBTAINED. Factors which MUST influence auditors decision. THE ASSESMENT of Inherent Risk and Control Risk at the client. :if higher risk more evidence from most reliable source needed. THE MATERIALITY of Item Being Examined: e.g. if stock is very material auditor must get more of appropriate evidence.-why greater likelihood of material misstatement.

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SUFFICIENT APPROPRIATE EVIDENCE

3) Experience from Previous audits (at same client). HISTORY 4) Results of audit procedures ALREADY CONDUCTED E.g. if test of debtors was good, then do less other tests. 5) RELIABILITY and Source of info. Available. If no reliable tests available, then much more of less reliable tests must do. 6) PERSUASIVENESS of the audit evidence: e.g.: evidence gathered on one section of audit which is Supported by evidence from another section = more persuasive .If it Contradicts it = less persuasive.

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ASSERTIONS

FINANCIAL STATEMENT ASSERTIONS: 1)The OBJECTIVE of an audit: is for an auditor to EXPRESS an OPINION on whether the FINANCIAL STATEMENTS are FAIRLYPRESENTED. In all MATERIAL ASPECTS after comparing it to an IDENTIFIED REPORTING FRAMEWORK (check other definitions of this before) 2)Embodiment of Assertions: the financial statements are the EMBODIMENT of the ASSERTIONS of the DIRECTORS of the COMPANY ,in the PRESCRIBED FORMAT , on the FINANCIAL RESULTS and PERFORMANCE of OPERATIONS ,which they are managing on behalf of shareholders.

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ASSERTIONS

3)ISA 500R :

the auditor should use assertions for classes of transactions ,account balances, and presentation and disclosure, in sufficient detail to form a basis for the assessment of risks of material misstatement and the design and performance of further audit procedures.

4)It is the Auditors duty to gather sufficient evidence to support assertion being audited. 5)Every assertion should be considered for audit, but those assert. presenting highest risk of MATERIAL MISSTATEMENT by the AUDITOR in his' "OPINION on ... ", must be concentrated on.

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ASSERTIONS

6)CATEGORIES OF ASSERTIONS: ISA 500R Categorises the Assertions as follows:

a)Classes of Transactions and Events(for period) e.g:. sales, purchases, interest received b)Account Balances carried forward to next year (at year end)eg:property plant &equipment ,accounts receivabe c)Presentations and Disclosure :e.g. notes to bal. Sheet, contingent liabilities

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ASSERTIONS

1.Classes of TRANSACTIONS AND EVENTS: Assertions about (during period) 1.1.OCCURENCE : recorded trans. & events DID occur and DO PERTAIN to THIS entity

1.2.COMPLETENESS :all that should have been recorded, were recorded ,none missing.
1.3.ACCURACY :1-Amounts & 2 Data were recorded appropriately. 1.4.CUTOFF : in right accounting period.

1.5.CLASSIFICATION (and UNDERSTANDABILITY) : recorded in correct account names.

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ASSERTIONS

2.ACCOUNT BALANCES :Assertions about(end period).

2.1.EXISTENCE : assets, liabilities, equity's DO actually exist.

2.2.RIGHTS AND OBLIGATIONS : entity holds rights to assets , liabilities are obligations of this entity , named shareholders. : do hold the rights to the equity. +2-ALL ENCUMBERENCES on ownership must be . .. .:Disclosed 2.3.COMPLETENESS : all that should have been recorded, were recorded, none missing.

2.4.VALUATION AND ALLOCATION: assets ,liabilities , equity recorded at appropriate valuation amounts and any resulting :valuation adjustments or allocation adjustments are appropriately recorded . ALSO , :DEPRECIATION and OBSOLECENCE ALSO allocated to correct accounts in ledger

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ASSERTIONS

3.PRESENTATION AND DISCLOSURE: Assertions about. 3.1.OCCURENCE 3.2.AND RIGHTS AND OBLIGATIONS. :disclosed events ,transactions& other matters DID occur and Do pertain to this entity. 3.3.COMPLETENESS : All matters that should be disclosed in FIN Statements., were disclosed, none missing. 3.4. CLASSIFICATION AND UNDERSTANDABILITY. : Financial info./disclosures are appropriately/ properly PRESENTED and DESCRIBED, and EXPRESED CLEARLY ., and classified correctly in ledger 3.5. ACCURACY amounts disclosed in e.g. notes are not junk 3.6.VALUATION & ALLOCATION. : 1-FINANCIALand 2-OTHER INFORMATION ( e.g. notes on union problems) are disclosed FAIRLY and at APPROPRIATE AMOUNTS. (at correct valuation amounts and in a correct and proper 'FAIRLY presented' - manner.)

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ASSERTIONS
TRANSACTION EVENTS ACCOUNT BALANCES PRESENTATION DISCLOSURE

No 1 2 3 4 5 6

ASSERTION COMPLETENESS OCCURRENCE EXISTENCE ACCURACY CUT OFF CLASSIFICATION (and for Pres. & Disclosure: UNDERSTANDABILITY) RIGHTS and OBLIGATIONS VALUATION and ALLOCATION

7 8

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ASSERTIONS

EXAMPLES OF ASSERTION CLASSIFICATION IN PRACICE: 1. SALES TRANSACTIONS: 1.1. FIRSTLY: all Sales figures PLUS all disclosures pertaining to sales should be checked for :( leave out Occurrence for disclosures though) 1.1.1. Occurrence: all sales included DID actually occur. (Not fictitious) 1.1.2. Completeness: all sales made were included in sales total, none left out. 1.1.3. Accuracy: all sales recorded appropriately, meaning prices discount & vat rates are correct & correctly calculated. 1.1.4. Cutoff: All sales recorded occurred in accounting period being audited.

1.1.5. Classification: All sales posted to proper account incl. Contra accounts VAT, DISCOUNT, CREDITORS.

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TRANSACTION & EVENTS

EXAMPLE
Occurrence Completeness Accuracy Cut-Off Classify & Understand

ACCOUNT BALNCES Plant &Equipment

Existence

Completeness

Rights & Obligation Holds rights to ownership +2Encumbrances On ownership disclosed. Accuracy

Value at. & Allocate Reflected at appropriate amount incl allocat. 1Obsolete +2-Dep. Cut-off Classify & Understand Rights & Obligat

All in bal. All owned is Sheet existed included, none at time of bal. left out. sheet

PRESENTATION & DISCLOSURE

Occurrence

Completeness

2.Auditor self stock count= 'existence some 'valuation' BUT not 'rights' e.g. could be uncollected but sold .NOR 'completeness' yet because must first be traced to records to determine if all were included in records. 3. Sheet to shelf = existence BUT shelf to sheet =completeness. 4. Tests of controls specifically as to accuracy will not prove validity (occurrence /existence?) or completeness.

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THE AUDITORS TOOLBOX

1. Auditor has ONLY 2 things in his TOOLBOX A. TESTS OF CONTROLS =to test if control procedures complied with B.SUBSTANTIVE PROCEDURES. =to test if verify / substantiate 1-TRANSACTIONS 2-BALANCES TESTS OF CONTROLS

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THE AUDITORS TOOLBOX

1) CATEGORIES OF TESTS OF CONTROLS: i) RE-PERFORMANCE: repeating 1-Wholly 2- In Part control procedures e.g.: re-perform bank recon. ii) INSPECTION: verify on docs. If control procedures did happen: e.g.: verify if transaction authorization signature is there. iii) ENQUIRY: ask person CONCERNED with control procedure as to effective operation of. NOT just accept mngmnts word. E.g.: find out who performs each procedure and what they do. IV) OBSERVATION: watch process/procedure being performed e.g.: watch what a receiving clerk does when supplier delivers goods. receiving clerk does when supplier delivers goods.

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THE AUDITORS TOOLBOX

2) Tests of Control are performed to obtain evidence of whether i) Controls suitably designed to (1)PREVENT (2)DETECT (3)CORRECT material misstatements) Operated effectively THROUGHOUT PERIOD AUDITED. 3) Good results reduce control risk and hence audit risk, and then less time need spent on substantive tests.

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THE AUDITORS TOOLBOX

4) LIMITATIONS OF: tests of controls: a) Good when checked but not in the rest of the Fin.Year. b) Inherent risk? Ch7 e.g. 1-only test some 2- subjectivity-auditor own method 35) LIMITATIONS OF: internal controls: i) Cost exceeds benefitlimits capacity of internal controls. ii) Directed at routine transactions. miss non-routine e.g. sell copier.

iii) Human error. e.g.: calc. discount after vat.

iv) Collusion- e.g. fraudulent pay packet- collude wage clerk, foreman, personell mngr.

v) Mngmnt Override /Abuse of responsibility over internal control- e.g. mngr overrides stop on purchases for overdue acc.49

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THE AUDITORS TOOLBOX

SUBSTANTIVE PROCEDURES. 1) Tests controls cannot provide 100% assure so sustant.tests need be done. 2) SUBSTANTIVE TESTS BROADLY DISTIGUISHED INTO; a) Tests Of Detail. b) Analytical Procedures. (Very powerful tool)

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THE AUDITORS TOOLBOX

3) CATEGORIES OF SUBSTANTIVE PROCEDURES: i) REPERFORMANCE: repeating 1-Wholly 2- In Part same procedures performed by client e.g.: debtors age analysis. ii) INSPECTION: inspect 1-docs+records, or 2-tangible assets e.g.: inspect fixed asset to verify existence or inspect.Confirmation of Balance Certificate" from long term loan creditor. iii) ENQUIRY: 1-oral or 2-formal written: to inside or outside entity to get 1Corroborative evidence or 2-Plain knowledgeable person inside or outside entity. iv) CONFIRMATION: procedure of obtain response to an enquiry to corroborate info. in the acc. records. Knowledgeable person inside or outside entity v) RECALCULATION: check arithmetic on source docs & records. E.g.: check depreciation calc. vi) ANALYTICAL PROCEDURES: analysis of ratios + trends , then investigate inconsistent deviations .(statistics)

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THE AUDITORS TOOLBOX

4) Substantive procedures are performed on a) Balances Assertions=; Existence, Completeness, Rights & Obligations,Valuation & Allocation. b) Transactions Assertions=; Occurrence, Completeness, Cutoff, Classification & Understandability, Accuracy 5) Financial stat. consist of only a) Collection of balances - bal sheet b) Summary of totals inc.stat

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THE AUDITORS TOOLBOX

6) VOUCHING AND VERIFYING:

a) Vouching: (To Vouch) TRANSACTIONS auditing.

b) Verifying: BALANCES auditing. c) Example: i) VOUCH a sales transaction = inspect docs + enquire discounts + recalculate ii) VERIFY a debtors balance = confirmation in writing from debtors + enquiries as to calc. of prov. bad debts. +re-perform aging analysis of debtors. 7) DUAL PURPOSE TESTS: Some tests can be a test of control and substantive test at same time e.g.: bank recon. Re-perform = test of control (recon is a control) and substantive test (bank balance).

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Ability

Is what you're capable of doing. Motivation determines what you do. Attitude determines how well you do it. THE ENDfor now