AUDITING & ASSURANCE SERVICES (M)

LECTURE AND TUTORIAL OUTLINE FOR WEEK 2 (WEEK OF MARCH 11th 2019)
FUNDAMENTAL AUDIT CONCEPTS

1: INTRODUCTION
In Lecture we commence our exploration of fundamental audit concepts. We consider
• Financial report assertions and audit objectives
• The nature of audit evidence; and
• The concepts of sufficient appropriate evidence

FINANCIAL REPORT ASSERTIONS AND AUDIT OBJECTIVES

Our definition of auditing that was introduced in the first lecture highlighted management
assertions. There, we defined auditing as,
“ A systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of
correspondence between those assertions and established criteria and
communicating the results to interested users.” (American Accounting Association,
1964, cited in Leung et al., 2018, p.3)

We say that when preparing financial reports, those responsible are making set of assertions
(statements that are claimed to be true) about the information they include in them. For
example, they are asserting that all transactions that should have been included were, and
that only those transactions that pertained to the entity within the accounting period were
included.

Assertions can be explicit or implicit. For example, by recognising inventory of $16m as a

current asset in the Balance Sheet, there is an explicit assertion that a specific quantity of
inventory existed at balance date, and that the correct valuation was $16m. There is also an
implicit assertion that all the inventory that should have been recognised was; and that it was
owned by the organisation.

Since the auditor’s objective is, to express an opinion on whether the financial report was
prepared, in all material respects, in accordance with an identified financial reporting
framework, the auditor effectively asks the question: are the assertions made by
management justified? In answering this question, the auditor establishes a specific audit
objective for each management assertion, which thus enables the testing of the
management assertion. For example, if management asserts that an asset is valued at a
particular amount, the auditor asks the question (sets the specific audit objective): is that
particular valuation justified? Similarly, if management asserts that the liabilities it has

1
recognised constitute a complete record of the liabilities owed at balance date, the auditor
asks the question (sets the specific audit objective): is the list of liabilities complete? Thus,
setting audit objectives that mirror management assertions provides the auditor with a
framework for evidence collection and evaluation.

Management assertions fall into two categories: those concerning transactions and events
and related disclosures, and those concerning account balances and related disclosures.
These are listed at paragraph A128 of ASA 315.

Management assertions are defined at paragraph A128 of ASA 315 as follows:

Assertions about classes of transactions and events, and related disclosures, for the period
under audit. These are:

Occurrence transactions and events that have been recorded or disclosed, have
occurred and such transactions and events pertain to the entity.

Completeness all transactions and events that should have been recorded have
been recorded, and all related disclosures that should have been included in the
financial report have been included.

Accuracy amounts and other data relating to recorded transactions and events
have been recorded appropriately, and related disclosures have been appropriately
measured and described.

Cut-off transactions and events have been recorded in the correct accounting
period.

Classification transactions and events have been recorded in the proper accounts.

Presentation transactions and events are appropriately aggregated or

disaggregated and clearly described, and related disclosures are relevant and
understandable in the context of the requirements of the applicable financial reporting
framework.

Assertions about account balances, and related disclosures, at the period end. These are:

Existence—assets, liabilities, and equity interests exist.

Rights and obligations—the entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.

Completeness—all assets, liabilities and equity interests that should have been
recorded have been recorded, and all related disclosures that should have been
included in the financial report have been included.

2
 Accuracy, valuation and allocation—assets, liabilities, and equity interests have
been included in the financial report at appropriate amounts and any resulting
valuation or allocation adjustments have been appropriately recorded, and related
disclosures have been appropriately measured and described.

Classification—assets, liabilities and equity interests have been recorded in the

proper accounts.

Presentation— assets, liabilities and equity interests are appropriately aggregated

or disaggregated and clearly described, and related disclosures are relevant and
understandable in the context of the requirements of the applicable financial reporting
framework.

AUDIT EVIDENCE

Audit evidence is the information on which the auditor must rely to form an opinion. Audit
evidence is gathered from many sources, including the accounting information system, other
internal sources, and a range of external sources. A distinction made by auditors is between
underlying accounting data, and corroborating information. Underlying accounting data
includes, for example, journals, ledgers and worksheets; while corroborating information
includes documents such as cheques, invoices and contracts.

That is, corroborating information is the information that those preparing the financial reports
would have used to support journal entries and workings, which, in turn, can be used by the
auditor to test the validity of journal entries and workings.

SUFFICIENT APPROPRIATE EVIDENCE

A key issue for the auditor is to determine what constitutes “sufficient appropriate evidence”,
so that the audit opinion is sound. In this lecture we explore what is meant by the term,
“sufficient appropriate evidence”. Sufficiency refers to the quantity of the evidence collected
and tested; while appropriateness refers to the reliability and relevance of the audit
evidence. We see that there are five criteria for evaluating the reliability of audit evidence:
these are defined at ASA 500. A31. To determine the relevance of audit evidence we need
to consider (1) direction of testing; (2) timeliness; and (3) the appropriateness of procedure.
(In next week’s lectures, we explore how the auditor determines just what constitutes
sufficient audit evidence in any given audit engagement by applying the Audit Risk Model.)

3
2: LEARNING OBJECTIVES
1: Understand that, essentially, financial reports are a set of assertions.
2: Understand how the auditor uses assertions when planning and executing an audit.
3: Understand what is meant by ‘audit objectives’, and how they are developed.
4: Understand the nature of audit evidence.
5: Understand the concept of “sufficient appropriate audit evidence”.
6: Understand the criteria for determining the reliability of audit evidence.
7: Understand the concept of “relevance” of audit evidence.
8: Understand the concept of direction of testing.

3: REFERENCES
Textbook: Audit and Assurance (First Edition). pp. 280-284; and 333-341.

Handbook
• Understanding Financial Statement Audits: A Guide for Financial Statement Users-
Chapter 1, the paragraph titled, “The Financial Statement Audit”.
• ASA 315 Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and Its Environment, paragraphs A127 and A128
• ASA 500 Audit Evidence, paragraphs 1 to 11 and A30-A35
• Understanding Financial Statement Audits: A Guide for Financial Statement Users-
Chapter 1, the paragraph titled, “The Financial Statement Audit”.

Readings:
Reading 5: Trotman, K. and Gibbins, M. (2016). Financial Accounting An Integrated
Approach, 6th Edition, Accounting Books and Records, pp. 140-147. South Melbourne,
Thomson.

Reading 6 Whittington, Ray & Pany, Kurt, Principles of Auditing & Other Assurance
Services, 18th ed., McGraw-Hill Irwin, New York, pp. 141-149

Additional Guidance:
“Assertions and Audit Objectives”
“Source Documents”.
Please note that as well as the guidance on source documents there are some examples
of source documents (Credit Approval Form, Sales Order, Shipping Note, and Sales
Invoice). These will be used as lecture illustrations

4
4: WEEKLY QUESTIONS (To be completed prior to tutorial in week of March 18th)

QUESTION 1
(a) Explain the term, “the audit trail”.

(b) If an entity recognises $20m of inventory in its Statement of Financial Position, what
assertions are management making about inventory?

QUESTION 2: Audit evidence comes in many forms. Give one example of each of the
following forms (please note that these are not necessarily mutually exclusive):
1. Underlying accounting data
2. Corroborating information
3. Documentary evidence
4. Third party representations
5. Physical evidence
6. Computations
7. Data interrelationships
8. Client representations

QUESTION 3: How does an auditor use management (financial report) assertions when
conducting an audit of a financial report?

QUESTION 4: For each of the following statements identify the relevant assertion and
classify it as transaction related or balance sheet related

i. The auditor inspected the draft financial statement to determine whether or not
the requirements of paragraph 73 of AASB 116 had been complied with

ii. The auditor reviewed purchase transactions that had been recorded during the
three working days before balance date and the three working days after
balance date to determine the accounting period in which they had been
recorded.

iii. The auditor reviewed contracts for the purchase of plant and equipment to
determine at which point title to goods sold transferred to the buyer.

iv. The auditor compared the carrying amount of certain lines of inventory with the
advertised selling price when performing the audit of a mobile-phone retailer.

v. When visiting the client’s premises, the auditor inspected the asset register and
selected four items of plant and equipment. She then located each of the four
items in the factory and inspected them.

5
 vi. The auditor inspected the appropriate documents and records to determine if
all sales for the period had been recorded in the sales journal.

vii. The auditor inspected correspondence between the client and debtors in order
to determine whether or not the client’s provision for doubtful debts was
reasonable.

viii. The auditor inspected the draft financial statements to determine whether or
not write-downs of inventory had been reported in accordance with AASB102

ix. The auditor inspected the purchases journal and verified a selection of entries
by inspecting receiving reports.

x. Every Friday afternoon, a clerk inspects a sample of sales records to ensure

that the account codes are correct.

QUESTION 5:
(a) Explain the term, “direction of testing”.

(b) Compare a test for the understatement of a transaction class with one for the
overstatement of a transaction class.

(c) In the table below, six situations involving direction of testing are represented.
Consider the assertion being tested, the starting point, the information used to verify
the information you start with, and whether the direction of testing is one of tracing or
vouching. Complete columns 1 to 3 and indicate, in column 4, whether the test
involved tracing or vouching

1 2 3 4
Assertion Starting point Verification Tracing or
Vouching
Completeness Physical asset
Sales journal Shipping note
Existence Inventory record
Completeness Receiving note
Purchases Journal Receiving note
Completeness Shipping note
Payroll journal timesheet

6
QUESTION 6 (Using the Auditing Standards)
ASA 500 Audit Evidence sets out audit requirements and provides guidance on the matter of
audit evidence. Locate this standard and answer the following:

(a) What does this standard say about the sources of audit evidence? In your answer
cite the paragraph numbers from the standard to support what you say.

(b) Outline the five criteria for judging the reliability of audit evidence that are posited in
ASA 500. In your answer cite the paragraph numbers from the standard to support
what you say.

TUTORIAL WORKSHOP QUESTIONS (FOR DISCUSSION IN TUTORIALS IN THE WEEK

OF MARCH 18th 2019)

QUESTION 1

• This is a practical exercise that explores the concept of “direction of testing”.

• Students should select two people from each group (table) to undertake the audit of
moveable furniture (tables/ desks and chairs) in the tutorial room.
• One student will test for the existence assertion; the other will test for the
completeness assertion.
• The instructions for undertaking these tests are provided on a separate handout
(AUDIT PROGRAM FOR PROPERTY PLANT AND EQUIPMENT).
• The two students who are undertaking the testing should discuss the requirements
with others at their tables, conduct the test, and then return to the table and discuss
the results.
• Students who are not undertaking the testing should discuss the exercise.
• The Tutor will then lead a class discussion on the testing.
• PLEASE SEE the sheets titled, “AUDIT PROGRAM FOR PROPERTY PLANT AND
EQUIPMENT” (one sheet for “Completeness” and one for “Existence”)

LEARNING OBJECTIVE:
Lecture 2, Part 2, Learning Objective (8): Understand the concept of direction of testing.

REFERENCES:
Lecture Slides: Lecture 2, Parts 1 and 2, slides 74-75

7
QUESTION 2
Question 2(a): You are working in the accounts department of Tom’s Toys Pty Ltd (Tom’s
Toys), a toy wholesaler that uses a perpetual inventory system. Tom’s Toys determine its
selling prices by applying a mark-up of 50% on cost. Your colleague hands you the following
document so that you can prepare the appropriate journal entries. What journal entries do
you make? Include the narratives. NOTE: Tax is ignored in this question

COPY No 3
Tom’s Toys Pty Ltd
ABN 502 4532 5638

Tax Invoice
Date Invoice No
07/ 03 / 2018 2016 0543
Page No. 1 of 1

16 Grange Street Invoice To:

Adelaide, SA, 5000 Brighton Toys
632 Jetty Rd
Ph:08 8345 6732
Brighton
F: 08 8345 8564
SA 5048
www.Tom.com.au
tt@gigapond.com.au

Customer No. Sales Order No. Salesperson Date of Sale Date Shipped
165 2016 3456 David March 2nd 2018 March 4th 2018

Description Item Code Quantity Price Amount

Train sets 4567 3 $45.60 $136.80
Direct Debit Details Total Ex GST $136.80
Account Name: Tom’s Toys Pty Ltd
BSB: 065-321 GST
Account No: 127 396 821 Paid
Balance Due $136.80
Net 30 Days

Question 2 (b):
(i) What is the source document that can be used as evidence that a sale occurred?
(ii) What is the source document that can be used as evidence that a purchase
occurred?

LEARNING OBJECTIVE: Lecture 2, Learning Objective (2) Understand the nature of the
documents and accounts used in the sales and collections and purchases and payments
activities.

8
REFERENCES:
Lecture Slides: Lecture 2, slides 66-67 and 72-73

Reading 5: Trotman, K. and Gibbins, M. (2016). Financial Accounting An Integrated

Approach, 6th Edition, Accounting Books and Records, pp. 140-147. South Melbourne,
Thomson.

Additional Guidance: Source Documents

QUESTION 3 (Use of Handbook)

Required

(i) For each of the paired statements below identify the statement that describes the more
reliable evidence collection procedure.

(ii) For each pair, state the criterion (from ASA 500.A31) that you applied in answer to (i)
above.
Pairing Statements Reliability Criterion
(more/less)
1 The auditor inspected a copy of a major contract
held by branch office
The auditor inspected the original contract held at
head office
2 The auditor obtained a bank statement from the
client’s bank to determine the ending balance of
cash.
The auditor asked the chief accountant to show
him the ledger so that he could determine the
year-end cash balance.
3 The auditor asked the chief information officer
how the firm ensured only those with authority to
update an account had access to the account.
The auditor observed the data entry clerk logging
on to his workstation by entering a username and
password in order to update accounts.
4 The auditor wanted to know the selling price for
inventory after balance date so he inspected a
sales catalogue
The auditor wanted to know the selling price for
inventory after balance date so he inquired with
sales staff

9
LEARNING OBJECTIVES: Lecture 2 (Part 2) Learning Objective (6) Understand the criteria
for determining the reliability of audit evidence.

REFERENCES
Textbook: pp. 336-337
Lecture Slides: Lecture 2, slides 55-60
Handbook: ASA 500. A31

QUESTION 4

You discuss the financial statements with the financial controller. She makes the following
statements.
(a) The total figure for financial liabilities includes the bank overdraft, and all other loans
from financial institutions.

(b) All of the items that that make up the balance of property plant and equipment
recognised in the Statement of Financial Position are located in the factory.

(c) When accounting for inventory, I investigated current market conditions and
determined that it was appropriate to recognise inventory at historical cost.

(d) We have thirty laptop computers that are used by sales staff. Sixteen were supplied
to us by a distributor under finance leases that have 18 months to run, while the
remainder were purchased in May this year.

(e) The senior accountant performed an ageing of debtors. I checked it and agreed with
her that the provision for doubtful debts is appropriate.

Required: For each of the above statements, identify the management assertion.

LEARNING OBJECTIVE Lecture 2 (Part 2): Learning Objectives (1) Understand that,
essentially, financial reports are a set of assertions.

REFERENCES Lecture Slides: Lecture 2, slides 4-37

Textbook: pp.280-284
Handbook: ASA 315.A128

10